How to Get Out of an Upside-Down Car Loan

Point of Interest

If you have an upside-down car loan, there are ways you can work to get out from underneath the loan and minimize the impact on your financial picture. 

Upside down is not a phrase you want to hear when you’re talking about your car — physically or financially. While small down payments, flashier more expensive cars and lower payments may seem attractive at the time of purchase, they can drive you into a tough financial spot over time by causing you to owe more on your car than it’s worth.

What is an upside-down car loan?

The definition of an upside-down car loan is simple, but the surrounding factors can get confusing and complex to understand. An upside-down car loan occurs when you owe more on your loan than your car is worth. For example, if you still owe $10,000 in interest and principal payments on your car, but your car is only worth $6,000 on resale value, you are upside down on your car loan.

Instead of having positive equity in your car, you have negative equity. With this example, you have $4,000 of negative equity you are responsible for.

How does this happen? There are many different ways someone can find themselves upside-down on a car loan. According to vehicle history report company Carfax, cars can lose up to 10% of their value in the first month after they’re driven off the dealership lot, and can depreciate more than 20% within the first year. This alone can get you behind the curve and upside-down if you don’t make much of a down payment when you purchase your car.

Here’s an example. Let’s say you’re looking at purchasing a $20,000 car. You decide to put down a $1,000 down payment, and you get an interest rate of 5.6% over 60 months (5 years). If the car loses 10% of its value in the first month, it’s now worth $18,000. After you make your first payment of around $364, you will still owe $21,464 over the life of the loan (including principal and interest). At this point, you owe more than your car is worth and are upside-down on the car loan.

As your car continues to lose value, the level at which you are upside down may continue to grow. Additionally, you can get upside-down on your loan if you take an unfavorable loan with too high of an interest rate.

Does this create problems? Not immediately. As long as you continue to make good on your loan payments, you will be fine.

However, if something happens where you are having problems making payments and need to sell your car, you will be significantly short on the funds needed to pay off the remainder of the loan. Additionally, if you are in an accident and the car is totaled, your insurer will most likely pay out the current value of the car. You’re still going to owe the larger amount of the loan, though, which can create significant issues.

How to get out of an upside-down car loan

If you find yourself upside down on a car loan, it’s not the end of the road. You have options to get back on track and flip your loan right side up. Remember, a car that’s upside-down on the loan is not an immediate problem, so you do have some time to try and get the situation remedied.

1. Make additional or larger payments

You’re not really able to increase the value of your vehicle, so you can only make changes to the “owed” side of the upside-down loan equation. If you can lower the amount that you owe on the car, you can catch up to the value of the car and get your loan back on track. The best way to do this is to make additional payments on your loan or make larger payments. This will require the financial flexibility to make extra payments, but if you reorganize your budget, you may be able to start getting back on track.

2. Look into refinancing options

While refinancing is not going to change the value of your car, it may help to adjust the amount you owe on your loan with a better interest rate. Even if a refinance does not fully get you out from under the upside-down car loan, it can make the road to recovery shorter and more manageable. If rates are low or your credit profile has recently improved, look into refinancing your loan to save on interest costs.

3. Cancel any additional charges

While additional service programs and amenities may have looked like a good idea during purchase, you may want to look to cancel them to start getting on the right side of your car loan. If it’s something that’s a necessity, like a warranty that could put you at greater financial risk by canceling it, don’t remove it. If it is something like a luxury service or maintenance plan that you can do without, get it removed. Once you do, take that extra money and start putting it toward your loan as additional payments.

4. Push through the process

Car depreciation slows as time goes on. The largest hit to value comes early in the life of the car and starts to slow the longer you own the car. What this means is that you can continue to make regular payments on your car and wait out the problem. This does continue to put you at risk, though, in case of a major accident or sudden life change. If you are unable to find additional money or refinance, this could be your only option.

The Final Word

Being upside-down on your car loan is not fun, but it’s not an instant shot to your financial well-being either. You are at risk of financial issues, however, if the car gets totaled, your financial picture changes or you suddenly need to get into a different vehicle. The key to getting out from under an upside-down car loan starts with realizing it’s a problem. From there, you can look to implement some of these strategies to try and take your car loan situation for a U-turn.

Jason Lee

Personal Finance Contributor

Jason Lee is a seasoned copywriter with a passion for writing about banking, tech, personal growth, and personal finance. As a business owner, relationship strategist, and officer in the U.S. military, Jason enjoys sharing his unique knowledge base and skill set with the rest of the world.