Paycheck Chronicles

From the Mailbag: What To Do With an Upside Down Car Loan


Upside_down_car I recently received this email:

How do we go about downsizing our vehicle that we are upside down in?  We are about $8,000 over our head with this vehicle and want to get something more affordable, but basically are stuck with it.  Simply giving it back is not an option due to the negative credit hit that we would take.  We have tried selling it ourselves, but since the gas fiasco within the last year no one wants to buy a full size SUV (we are a family of 5, two of which are teens).  We have tried to trade it in but the dealers won't give us anything near what we need for it.  We have brought our price down several thousand dollars below what we owe just to get rid of it.  Any ideas for us?  Does anyone else have any constructive comments or suggestions?

Here's what I think:

Photo by:  Editor B

No doubt about it, you are stuck in a hard place.    Owing more on a car than it is worth is a rough situation, and that situation is even worse right now because new cars are selling for less money, and dealers & manufacturers are offering amazing deals to entice people to buy new cars.  This is driving the price of used cars down as the demand falls.

Consider your reasons for getting rid of the car.  Do you want to get rid of it because of the car payment, the insurance, or the amount of gas that it uses?  Another big factor is whether you will need to purchase another vehicle to replace the one you're getting rid of.  (That is the situation about which I will talk because that is the most common.)

Most often, people want to switch to a smaller car because the car payment is too high.  Unfortunately, the best way to get out from under an upside down loan is to keep the car and continue making the payments.  If you are at all able to make the payments, tighten the belt in other areas and keep chipping away at that debt.  Eventually you will reach the break-even point and be able to sell the vehicle for near the same amount that you owe.  Even though it seems like you should be able to solve your problem by selling the car, even for less than you owe, it usually doesn't make sense mathematically.  You'll either need to come up with cash to pay off the loan when you sell the car, or you'll have to take out a personal loan for the difference.  If you have the cash on hand, you can use that to buy the loan down to a point where you can sell it today.  If you need to take out another loan, then you aren't reducing your debt at all.

If the car payment is absolutely killing your budget, look into refinancing for a longer term.  I wouldn't recommend this if you have any other options.  Refinancing for a longer term will keep you upside down longer.  Before you start shopping for a new loan, check to make sure that the existing loan doesn't have a prepayment penalty.

Many dealers are willing to roll over your negative equity into the loan for a new car, but there are several reasons this is a bad idea.  First, you'll be even further upside down as soon as you drive the new car off the lot.  Second, you will nearly always be getting a higher interest rate.  Third, in order to be able to afford all this debt, you'll be paying for the new car for a lloonngg time.

Another idea that I have heard suggested is putting your car up for sale, but rather than asking for a dollar amount, ask for the buyer to take over your payments.  I can't imagine why anyone would want to buy a car that is upside down, but it might be worth a try.

If you do decide to keep the car, consider whether it would be financially smart for you to try to get "gap" coverage.  In the event of a loss, this insurance pays for the entire amount owed on a car regardless of the amount owed.  While gap coverage is usually purchased at the time that you purchase the car, some insurers will allow you to add gap coverage at any time during the loan.  This will protect you from having to come up with thousands of dollars if the car is totaled in an accident.  If you are in a tight financial situation and are having trouble paying for your car, gap protection will keep you from financial disaster in case your car is completely wrecked in an accident.

The sad fact is that there isn't a quick or painless solution to getting out from underneath an upside down car loan.  With some determination, you can hopefully rid yourself of this burden and get into something more affordable for your family.

Thanks for your letter, and good luck!

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