What Does It Mean When Your Loan is Underwater?
As new car models for next year start showing up on dealer lots, people will be hurrying to get the latest deals and newest features. Many of these people may still be paying on their current vehicles. Yet, the lure of dealer incentives and low rates causes many of them to say goodbye to their old cars. Unfortunately, this scenario can lead to people being underwater on their auto loans. This is also called an upside down car loan.
What is an Underwater or Upside Down Car Loan?
Sometimes, you will hear the words “underwater” and “upside down” when referring to auto loans. Technically, this means you owe more money on something than what it’s worth. It can refer to both auto loans and home mortgages. In this instance, we’ll be focusing on car loans as an example.
Let’s say you purchase a new vehicle for $25,000. Unlike houses that typically appreciate in value, cars depreciate the moment you drive it from the lot. Also, they continue to lose value every year. A $25,000 car can depreciate around 10 percent (in this example, $2,500) the moment you get it home from a dealership.
So, you are getting a loan for $25,000 on a car that now has a value of $22,500. This example means that you are upside down, or underwater, with your loan by $2,500. This is called negative equity ($25,000 – $22,500 = $2,500). If you decide to sell the car for its current value of $22,500, you will still owe the lender the negative equity amount of $2,500.
How People Become Underwater or Upside Down on a Car Loan
People can find themselves underwater on their loans due to the following reasons:
- Not placing a large enough down payment on the car to lower the amount that is borrowed
- Extending the car loan term causing them to pay more interest over a longer period of time
- Making minimal payments or missing monthly payments
- Continually rolling an old loan into a new loan
These scenarios can have a snowball effect. If you are the type of person who purchases a new car without completely paying off your current loan, you’re going to be underwater soon enough.
Keeping Your Finances Above Water
The best tip is to keep your existing car until the loan is paid off. Then, you can sell it without any worries of carrying negative equity. You can usually make higher monthly payments and put extra funds directly towards your loan principal. By doing this, it helps lower the amount you owe on your loan and enables you to pay off the loan quicker.
Additionally, consider refinancing the loan if you are paying a high interest rate. This will help you save on interest as well as obtain a more favorable loan term to prevent you from being underwater. Check our current auto loan rates to see if refinancing makes sense for you.
We’re Here to Help!
Before you go car shopping, contact Money Credit Union at (315) 671-4000, or chat with us online. Ask about your current loan balance and NADA value. This will help you understand if you are underwater or have an upside down car loan.
Each individual’s financial situation is unique and readers are encouraged to contact the Credit Union when seeking financial advice on the products and services discussed. This article is for educational purposes only; the authors assume no legal responsibility for the completeness or accuracy of the contents.
