How to Buy a Car If You're Upside Down on Your Loan
Written by
Ann Herro has been writing about insurance and employee benefits for over 15 years. She covers topics ranging from car insurance to healthcare costs.
Reviewed by
Cara Carlone is a licensed P&C agent with 20 years of experience. She has her P&C license in RI and TX and holds CPCU, API, and AINS designations.
Post-pandemic economic problems have left many Americans with large amounts of debt and other financial difficulties. One such problem is the upside down car loan.
You have likely heard about the many houses that homeowners have walked away from once they owed more than the home’s value. Similarly, car owners are finding themselves perplexed when the amount they owe on a car surpasses its current value.
What this means practically is that if you want to purchase a new car, you won't be able to trade in or sell your old car for enough to cover the outstanding balance on the loan. If you want to get out of the loan, you'll have to pay what's left out of your pocket.
While this can be a difficult situation, there are ways to get through it. And remember, before you buy any car, make sure you're covered with an affordable car insurance policy before you drive it off the lot. An independent insurance agent can help you get the coverage you need.
How Does an Upside Down Car Loan Happen?
An upside down car loan, also known as a negative equity car loan, is a loan where you owe more for your car than it is worth. You can get yourself into such a situation in a number of ways:
- If you trade in a car that has a loan balance and add that balance onto your new auto loan, you will owe more for the new car than it is worth.
- If you purchase a car with no money down, the car will depreciate much faster, leaving you with negative equity. Remember, cars depreciate in value by as much as 20% in the first year of ownership and can depreciate by 50% by the third year. If you bought your car with no money down, you are likely to owe more on it than it is worth for the five years that you have it.
- Even with a decent amount of money down, if you opt for an extremely long-term loan to keep your car payments low, your negative equity is not likely to improve.
- If you are in an accident and lack sufficient insurance coverage to cover any damage to your vehicle fully, your car will decrease in value drastically while your loan payment stays the same. This is why comprehensive, collision, and uninsured/underinsured motorist coverage is so important and is usually required by lenders.
No matter how you got into your upside down car loan, the most important thing is to rectify it as quickly as possible. This will save you a lot of money in the long run.
How Can You Get a New Car While Upside Down on a Current Car Loan?
So what do you do if you are upside down on your car loan but really want (or need) to buy a new car? You need to be very careful not to put yourself into deeper financial trouble by taking on more than you can reasonably afford to pay each month. If you default on your loan or fail to pay your other bills because you are trying to keep current on your car payments, you can find yourself with extremely bad credit.
Life is more expensive for people with bad credit. They typically have to pay higher interest rates on loans, frequently get stuck with late fees and other charges, and, believe it or not, they pay more for their insurance. This is because, statistically, those with bad credit pose a greater risk to insurance companies.
However, if you shop around for coverage, you might still be able to get a lower rate than you're currently paying. Independent insurance agents work with several insurance companies, not just one. They can show you several quotes for coverage, regardless of your credit score and financial past.
When it's time to buy a car with an upside down loan already in place, you need to be smart. You may want to look into some of the possible solutions below.
Save on Car Insurance
Our independent agents shop around to find you the best coverage.
Solution #1: Consider buying a used car
Just because you want to buy a car doesn’t mean it has to be a new car. Used cars are a financially savvy option, particularly for those in a position where their current car has an upside down loan. The original owners have already paid the bulk of the car’s depreciation, so your vehicle, which will be more affordable, will also retain its value longer.
- Pros: You will save money on depreciation costs and may be able to save a significant amount of money while you get your finances back in order. Once you have your loans completely paid off, you may even want to trade your used car in for a new one.
- Cons: If you have your heart set on a new car, this option will require you to wait until you are in a better position financially. You may not be able to find a used car in the make, model, or color that you prefer.
Solution #2: Find a new car with a great incentive
Look for deals and incentives. Cars that do not sell well can take up space on a dealer’s lot. This cramps that dealer's style, taking up space that more popular models could occupy. When this happens, either the car manufacturer will offer the dealer incentives in the form of large rebates, or the dealership will offer great incentives to their customers.
Either way, you can come out a winner. If the dealer offers you a rebate that can cover the remainder of your car loan, you can be free and clear of your upside down loan as soon as the rebate goes through.
- Pros: Allowing the dealership or the manufacturer to cover most or all of your remaining balance is a shrewd maneuver.
- Cons: The value of these poor-selling, incentivized vehicles tends to depreciate faster than other cars. In the short term, you may find yourself with another upside down loan. You can mitigate this problem by making extra car payments to the principal of your car loan for the first three years.
Solution #3: Roll your remaining debt into a new loan
The sales staff at a car dealership will usually be more than happy to offer you increased financing on your new car loan to encompass the old one. Of course, this is not a solution to getting rid of your upside down car loan, as it puts you right back into that situation. However, if you desperately need a new car, this is how you can buy one.
- Pros: You will be able to drive off the lot in a new car while putting your previous car loan to bed.
- Cons: You will still have an upside down loan, your car payments will be much higher than they would be otherwise, and you will end up spending a lot more in interest. This method is also risky. If an accident results in your car’s destruction or if someone steals your car, your insurance can only cover you up to the value of your car. So, you may end up with a pile of debt and no vehicle at all if such a thing were to happen.
Solution #4: Refinance your current car loan
If your current car is still drivable, you may want to consider keeping it for as long as possible while you pay off your current upside down loan. By taking out a home equity loan or unsecured loan with a lower interest rate than the one you are currently paying, you can opt for a car payment schedule that enables you to pay off the debt quickly.
You can speed up the process of improving your negative equity even more by paying extra toward your loan whenever you have extra funds available.
- Pros: This method will enable you to eliminate your debt in the fastest and least expensive way possible.
- Cons: You'll have to hold off purchasing a new car until you have successfully paid off your current one. This is fine if your current car is still running, but if you need to purchase a new car now, one of the other options will have to do. Another problem may exist if you have very bad credit. This may make it impossible to find a lender who will offer you a loan at a reasonable interest rate.
Solution #5: File for bankruptcy
This option is a last resort that you should consider only if you are struggling with overwhelming debt in all areas. If you are spiraling deeper into debt each month and can find no way out, bankruptcy may be your only solution. If you're court-approved for Chapter 7 bankruptcy, you may be able to eliminate your car debt. If you file for Chapter 13, you may be able to renegotiate your car loan to something more affordable.
- Pros: Bankruptcy will enable you to climb out of the red.
- Cons: This will leave you with extremely poor credit and can make it impossible to buy a new car for years to come. During this time, you may be limited to purchasing only used cars that you finance at extremely high interest rates.
Save on Car Insurance
Our independent agents shop around to find you the best coverage.
How an Independent Insurance Agent Can Help
Once you have managed to clear up your problems with your upside down car loan, do what you can to keep yourself from ending up in the same situation again. Try to avoid buying new cars unless you have the funds available to put at least 20% down.
Another important step along your path toward getting out of debt is making sure you have high-quality car insurance. Car insurance can help you steer clear of financial ruin if you cause a car accident.
When you're looking for car insurance, get help from a local independent insurance agent. Independent agents in your area can help you get the coverage that meets your needs and budget.