How to get out of a car loan when you’re upside down

Man sits in his car, wondering how to get out of his upside down car loanImage: Man sits in his car, wondering how to get out of his upside down car loan

In a Nutshell

Getting out of an upside-down car loan means making some difficult decisions. Depending on your financial resources and time frame, you may want to refinance your loan or pay off your negative equity in a lump sum.
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Do you owe more on your auto loan than your car is worth?

Going “upside down” or “underwater” on your auto loan happens when the market value of your vehicle is less than the amount you owe.

For example, say you still owe $30,000 on a car that you’d like to sell or trade in, but the most you’ve been offered is $20,000. That’s $10,000 in negative equity you’ll have to deal with. But how?

Unfortunately, this stressful financial situation doesn’t have a one-size-fits-all solution.

Car owners who are underwater may be torn between two undesirable options: making regular payments while potentially losing equity, or selling the car and eating the loss.

But those aren’t necessarily the only options. While repaying the full balance on your car loan may be inevitable, some ways of dealing with an upside-down car loan are better than others.

The wisest course of action may ultimately depend on your budget, your credit and the time frame in which you’d ideally like to pay off the loan.

On that note, let’s look at four steps that can help you determine the best option for dealing with your underwater loan.

  1. Calculate your negative equity
  2. Reach out to your lender
  3. Take on a new loan
  4. Consider getting rid of your car

1. Calculate your negative equity

Start by determining how far underwater you are. This can be done by subtracting the estimated value of your car from the remaining loan balance you owe.

Not sure what your car is currently worth? The Federal Trade Commission suggests checking these resources to help you figure out the value of the car.

There’s no single authoritative source when it comes to car valuation. We recommend checking more than one of the above resources to get a better idea of your car’s actual value.

To determine the loan balance, you need to subtract the amount you’ve already paid toward the loan from the original total loan amount.

Let’s say you do the research and learn that the market value of your car is roughly $15,000. If you owe $20,000 on your loan, then you are $5,000 underwater. In other words, you have $5,000 in negative equity.

Before you seriously consider selling your car or refinancing your auto loan, ask yourself if it’s within your financial means to pay down that negative equity. If you’re able to pay a lump sum without taking on more debt or jeopardizing your other assets, this is likely your best option.

2. Reach out to your lender

If you’re not in the position to pay down your negative equity in one fell swoop, you still have several alternatives worth considering.

The next step is to give your lender a call. Explain your situation and ask about any options it may offer to help turn the underwater loan around. Even if the lender says there are no options, it doesn’t hurt to ask.

If there’s room in your budget to pay extra money toward your principal each month, ask about setting up this option. Paying extra will help you get out of the loan faster and may allow you to bring down the balance at a rate that outpaces your car’s devaluation.

While you’ll still have to cover your negative equity, keeping your vehicle and paying off your loan can help you make the best of a bad situation.

It may be more painful in the short term, but at least you’ll have some equity to work with when you shop for a new vehicle later.

3. Take on a new loan

Is your lender unwilling or unable to help you get above water on your current loan? If you have reasonably good credit, refinancing at a lower interest rate could be the right move.

When refinancing an upside-down loan for a lower rate, it’s important to search for the right loan terms.

You might be tempted by low monthly payments, but lower payments extend the life of a loan and could lead to more negative equity.

Cars tend to depreciate in value rather quickly, losing about 20% of their value in the first year and up to around 50% to 60% after five years, so the faster you’re able to pay off the loan, the less likely you are to go underwater again.

Am I more likely to go underwater on a longer-term auto loan?

Stretching out the terms of your loan can help you afford a more expensive car in the short term, but it can expose you to long-term risk. If you want to purchase a new vehicle, you may be stuck paying off a large portion of your loan after your car’s value has significantly depreciated. 

4. Consider getting rid of your car

According to Edmunds, “the best strategy for getting above water is to scrap plans for a new car and stay with the one you have.” But if you’ve explored all other options and don’t see a way to catch up with your car’s depreciation, it may be time to say farewell.

If you’re set on selling your car, focus on getting the highest price. This will help you cover more of your loan balance.

Detailing the car and making any necessary mechanical improvements can help bring in better offers, but if your budget is restrictive, consider at least giving it a good wash and wax.

Trading your car in for a new set of wheels may be tempting since it saves you time and hassle, but trade-ins typically bring in less than private listings.

Also, remember that you’ll still have to cover the balance on your current loan. Most likely that balance will be rolled into your new car loan, heightening the risk of going underwater again.

Private sellers should consider using online resources to save money and reach the widest audience of potential buyers. Consider reaching out to your personal network and posting classified ads to free online sites like Craigslist.

If a private sale isn’t the right option for you, consider trading in your car that has an outstanding loan balance for a leased vehicle. That balance can be factored into the lease.

While leasing may not be ideal, Edmunds says, “you won’t have to worry about any of the resale value issues since the car goes back to the dealership at the end of the lease.”

Bear in mind that, either way, you’ll still be responsible for covering the negative equity you’ve accrued.

Next steps

Trying to escape from an underwater car loan can be incredibly stressful.

When making a decision about how to get out of a car loan, it’s important to avoid being impulsive. Trading your vehicle in may get you your next car faster, but it doesn’t get you out of repaying your debt.

Rather than search for a quick but costly solution, consider all of your options to find the best repayment method for you.

That could mean calling your lender and asking for help in the form of an improved repayment plan or a refinanced loan. It could also mean paying off your negative equity in a lump sum or switching to a lease so you don’t find yourself in the same situation again.

Whatever your decision, understanding the options can help you make the best use of your time and money as you work toward turning your underwater loan around.

About the author: Sarah C. Brady is a San Francisco–based financial consultant, workshop facilitator and writer. In addition to writing for Credit Karma, Sarah writes for Experian, LendingTree, Magnify Money, MSN News and more. In her … Read more.