Many of us, when buying a car, fail to appreciate that we’re buying an asset that will lose value over time. Or perhaps we do our homework, but shifting tastes in the market and the needs of the used car industry drives down what your car is worth without your noticing. Either way, it’s called an “upside-down” loan, and it’s a tough spot to be in.
What Is An Upside-Down Auto Loan?
When a loan is upside-down, that means you owe more on it than the property in question is worth. It’s also called being “underwater,” but regardless of the name, it’s a bad place to be in financially.
First of all, on the most practical level, it means you’re essentially throwing money away paying your car loan. If that weren’t bad enough, it also means that your trade-in, which for many of us is a key method of driving down the price of our next car, is worth less, so you’ll have to borrow more for your next car … which in turn increases your chances of being underwater on that car.
It’s fairly simple to find out if you’re upside-down on your loan. Just look up the value of your car in the Kelly Blue Book and compare that value to your current loan balance. If the loan balance is more than the value on paper, you’re probably upside-down. Once you’ve figured that out, it becomes a question of getting out from underwater, especially if you need a new car.
How To Flip Your Loan Right-Side Up
There are generally four strategies to get “right-side up” on your loan, and each have their benefits and drawbacks. The first is the simplest; keep your car until the value of your loan catches up to the value of the car. This is generally a viable strategy, but it may not work for everyone; older cars may be racking up repair bills and other costs, or may cost more to insure. Similarly, there’s a risk that you’ll get in an accident and your car will be totaled, paying out less than the overall costs of the loan.
The next strategy is refinancing your loan to reduce the interest and pay less overall on the car. This is fairly common and often very cost-effective, but by the same token, it means you’ll need to keep your car for longer. If it’s not in good working shape, that might not be a viable option.
Another strategy is to look for a car that comes with a financial incentive that makes up the cost of the previous loan. This can be a good short term solution if you need a new car … but remember that often the incentive comes out of the overall value of your new car, so you may find yourself upside-down again a few years down the road unless you’re aggressive with your loan.
Finally, you can simply take out a loan that covers both the cost of your new car and what you have left on your current car after trade-in. But be aware that this will also increase the risk you’ll be upside-down in the future, as you’ll be borrowing more.
No matter what your strategy, make a point to try to get out from under. Being upside-down on your car is already costing you money, and there’s no need to pay more.