When you are upside down on your car loan, it means that you owe a lot more than the vehicle may be worth. This may also be called negative equity or just being underwater. According to the most recent data available from Edmunds, 44% of recent car sales in April 2023 involved a trade-in with negative equity.
If you're underwater on your auto loan, it might create a deficiency balance when the vehicle gets totaled. And when you trade it set for a brand new car, it could lead you to have negative equity on the new car, making your situation worse. Fortunately, there are some steps you can take to alleviate the problem.
1. Consider Getting Gap Insurance
Gap insurance helps cover the gap involving the vehicle's value and the outstanding balance in your loan in case your vehicle is stolen or totaled within an accident.
Without gap insurance, your lender will typically require you to spend the money for difference. But when you have gap coverage, you are able to file claims to possess that provider remove the deficiency amount.
Bear in mind, though, that gap coverage can come with several limitations and exclusions, so be sure to review the small print carefully before buying an insurance policy.
2. Reduce The loan Faster
If you can afford it, consider accelerating your vehicle loan repayments. Even if you can only put a nothing more than your monthly payment toward the borrowed funds, that extra amount can directly pay down the main balance instead of going toward interest.
You may even consider reducing some of your discretionary spending, earning more cash or using tax refunds, a performance bonus at work or any other small windfalls to pay down your loan.
3. Keep the Car For Longer
While this might not assist you to if your car gets totaled in an accident, it could help you avoid making the issue worse by exchanging the vehicle when purchasing a new car. Remember, too, that depreciation typically slows down over time, so the longer you hold onto the vehicle, the greater your odds of doing depreciation together with your loan repayments.
Unless you absolutely need a new car, consider driving your current one around longer while you pay down your loan balance.
4. Consider Refinancing the Loan
If your credit score wasn't within the best shape when you initially took out the borrowed funds, a great chunk of your monthly payments might be going toward interest charges. If your credit has improved since that time, you may consider refinancing the loan to obtain a lower interest rate. Then, you can continue to transmit the original payment add up to the lending company and remove the debt faster.
Switching to a shorter payment term is yet another method to reduce the borrowed funds faster. Just make sure you really can afford the new, higher monthly payment.
5. Sell the Car to some Private Buyer
If you cannot escape the requirement for a new vehicle, you'll generally get less cash if you trade it in compared to selling it in a private-party transaction. This process takes more time and energy, but it could net you tons of dollars more than a trade-in.
Even when that's not enough to eliminate your deficiency, it might save you some cash over time.
How to prevent an Upside-Down Car Loan
An underwater car loan can impact your financial well-being, so it's important to try to avoid negative equity whenever possible. Here are some potential methods for you to achieve this:
- Make a larger down payment when you initially purchase the vehicle.
- Request a shorter repayment term.
- Research vehicles based on how well they hold their value.
- Avoid add-ons in the dealership, such as maintenance packages and additional features that increase the loan balance.
- Buy used or certified pre-owned vehicles rather than new vehicles to prevent a substantial drop in value throughout the newbie.
Build Your Credit to maximise Car Loan Savings
Whether you're upside down in your auto loan, your interest rate is among the most significant options that come with your vehicle loan. If your credit is in poor shape, interest rates can climb upwards of 20%, making monthly payments hard to afford. What's more, it's much more likely that you'll end up underwater because a lot of your monthly obligations goes toward interest fees.
So, whether you're planning to purchase a new car or you're trying to figure out what to do with your present one, the best choice to maximise savings is to improve your credit score. With Experian's free credit monitoring service, you will get use of your credit score and your Experian credit history, allowing you to see what your location is and determine which areas you are able to address to improve your creditworthiness.
You can also track your progress and find out how your actions influence your score. This process may take time, but when you're all set, you can make an application for an auto loan or perhaps a refinance loan with good chances of securing a favorable interest rate.