This is one of the most significant challenges encountered by the customer when dealing with a car loan. An upside-down car loan is a way in which the present loan balance is higher than the actual value of the car. We can call it underwater or stuck negative equity. Here, you owe more to the vehicle than the real worth of the vehicle.
Upside Down Car Loans
What is an upside down car loan anyways? An upside down auto loan is also referred to as a negative equity. Upside down auto loans is when the amount you owe on the loan is higher than the current market worth of your car. This will work against you if you wish to change your car. There are several things you can do to avoid or come out of a negative equity; one of it is to consider refinancing your loan or make extra payments.
As long as payment is being made for your car loan, you can’t experience upside down car loan. You can’t change the mortgage or the vehicle, the best you can do is to increase the level of your payment by tasking yourself financially in other to balance the loan on time before the interest rate increase.
Situations That Can Lead to an Upside Down Car Loan
- Little or no Down Payment: Not making a down payment or making small down payment can result in an upside down car loan. According to Edmunds, the recommended down payment on a car should be at least 12% which may be okay for a used car but might not work for a new car because a new car depreciates faster in its first year by at least 20%.
- Long Duration Loan: The longer the loan term, the more difficult it is to build equity. Spreading your loan for a long time means you are giving room for the car to depreciate while you are still paying debt on it, in the process you will be spending more on the car due to wear and tear.
- Depreciation: Cars are depreciating assets and as such they lose value over time. For example, new cars depreciate faster at 20% in their first year, and by the third year, they would have lost over 40% of their value. This can easily push you into negative equity and you struggle to build equity.
- Overpaying: Another scenario that can lead to an upside-down auto loan is when you pay more than the car is worth at the time of purchase, this will only magnify the effect of depreciation over time.
- Add-ons: Optional features and add-ons such as service contracts can increase the cost of your purchase and this will automatically add to the size of your debt.
- Carryover loan: Avoid carryover debt from one credit to the other to avid debt that will not be refundable because this will undoubtedly cause an upside down car loan or negative equity if the investment is higher than the value of the new car that you are purchasing.
How to Come out of Upside Down Car Loans or Negative Equity
To control or resolve an upside down car loan, you have to consider a few significant things:
- Refinance your Loan: Apply for refinancing to see if you can save more at a reduced interest rate, although you might have to pay more monthly.
- Repay your Loan Faster: You can pay more on your monthly payment if you have the ability to do so. It’ll help you to pay off the loan as fast as possible. Another way to do this is to make a down payment. This is in order to make the loan amount shorter. You’ll also get lower APR and interest rate.
- Sell Your Car Privately: Selling your car privately will enable you make more money than selling to a dealership. Although, you may have to handle the paperwork by yourself in this case.
- Wait to Attain Positive Equity: Ask yourself – do you really need to change your car? Can still make do with your current car? Why not wait to attain positive equity? Wait until you have paid a significant amount on your current car. You should consider this over buying another one and go for something you can afford.
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