Rising fuel prices, longer terms on loans, and rolling-over debt from prior vehicles can all contribute to a condition known as an upside down car loan. When this happens during a credit crunch, it's hard for consumers to escape this financial burden.
In this article, we're going to discuss what are called "upside down car loans." We'll provide a detailed definition of this term, explain how this can happen to consumers, and discuss some strategies borrowers can adopt to get out of this condition.
An upside-down car loan goes by many names. Sometimes they're referred to as "underwater loans," but perhaps the most descriptive term is a "negative equity" position in a car. Whatever it's called, the term simply means the car's owner owes more to creditors than it's worth if it were sold, or negotiated during a trade-in deal.
Fundamentally, everyone understands that a car depreciates over time. That is to say, as the car ages, the value of the car decreases. Collectible cars may be an exception to this rule; but, in general, the more miles someone drives a vehicle, and the longer they own it, the less it is worth on the marketplace.
Even under normal conditions, a car's value will decrease over time. But what many consumers don't realize is that when this value drops below the remaining principal balance on their car loan, they've gone upside-down. The car's value has dropped to the point that if they were to sell the vehicle, they wouldn't have enough money from the sale of the car to pay off their loan.
There are a several conditions, or causes, of upside down car loans. Some of these conditions are caused by the driver / owner of the vehicle, while others are the result of market conditions:
|3-Year Loan||4-Year Loan||5-Year Loan|
|Price Paid for Vehicle||$22,000||$22,000||$22,000|
|Ending Vehicle Value||$14,000.00||$14,000.00||$14,000.00|
|Equity in Car||$6,149.29||$2,233.48||$(108.40)|
This example illustrates how the length of a loan can turn it upside-down. Here we're showing a $22,000 loan carrying a 7.0% interest rate at the end of 24 months. At the close of this timeline, the car is now worth only $14,000; however, the five-year loan still has $14,108 of principal remaining.
If a car is worth less than owed to creditors, there are several tactics that can help relieve this problem:
Anyone that's desperate to get out of an upside-down car loan right away really only has one viable option: sell the car. Even if the car is sold, the loan still needs to be paid off. So in the end, the better approach might be to hold onto the car and continue to pay off the loan.
Car owners that believe the best alternative is to stop payments and have the vehicle repossessed should think twice before taking this approach. The laws in many states allow a creditor or lessor that has followed the correct repossession, and subsequent sale of the car, process to sue an owner to collect the monies required to pay-off any outstanding balance on the loan. By allowing the car to be repossessed, owners are needlessly harming their credit scores, and may even wind up paying attorney fees too.
About the Author - Upside-Down Car Loans (Last Reviewed on September 12, 2016)