
What Does it Mean to be Upside Down on a Car Loan?
So, what does it mean to be upside down on a car loan? Well, it means that the buyer’s car debt exceeds the value of the car. For instance, a buyer may purchase a car at $50,000 on loan, but in the course of repaying the loan, the car depreciates in value and is worth, say, $20,000. Such a buyer is said to have an upside-down or underwater car loan on their hands. That is because, even though the vehicle’s actual value has dropped to $20,000, the buyer is still obligated to pay the entire loan amount. In other words, the lender is entitled to the entire sum, including the ‘extra’ $30,000 that is over and above the car's actual value. In this case, that $30,000 is known as negative equity for the buyer. A car buyer who suffers an underwater car loan ultimately loses money as they end up paying an exorbitant price for the vehicle.Why it’s Risky to be Upside Down on a Loan
The most obvious detriment of an underwater loan is the financial loss that comes with paying more for the car than its actual value. In addition, the buyer could be exposed to the following risks:- Bad Credit Score
- Loss in case the car is totaled
- Difficulty trading in or purchasing a different car
How to Get Out of an Upside Down Car Loan
Different circumstances may inform buyers on how to get out of an upside-down car loan. Here are some common suggestions on how to go about it.- Large down payment
- Avoid cars with unnecessary add-ons
- Short term loans
- Refinancing
- Car swap
- Channel negative equity to a lease
How Does a Loan Turn Upside Down to Begin With?
An otherwise sound car loan can turn upside down pretty quickly. Several factors may contribute to this. Here are the most common ways car buyers find themselves with an underwater loan1. Failure to do their homework
Some car buyers neglect or fail to conduct prior research on the vehicle they are keen on buying as well as its pricing. Consequently, they may end up agreeing to buy the car at a price point that is way above the prevailing market rates. When this happens, such buyers immediately find themselves with an underwater loan upon signing the deal.2. Low or little down payment
All cars depreciate in value the moment they leave the showroom. To hedge against depreciation, it is common for wise car buyers to put down a substantial down payment on the car. Failure to do so may increase the amount of money owed (including the tax payable) as the car continues to lose value.3. Unduly long loan terms
Contrary to what some buyers may think, loans with extended payment periods are not cheaper. That is because the longer the repayment term, the higher the interest charged. The buyer, in such a case ends up paying far more than the vehicle’s worth. A similar situation might also arise where a buyer goes for unnecessarily low installments which prove more expensive in the end.How to know if your Car Loan is Upside Down
A potentially underwater loan may have one or several warning signs. Prospective buyers may look for the following elements when considering whether or not to take a particular car loan:1. Variation in car price
Where a dealer unilaterally varies the price of the vehicle to an amount not previously agreed on, the buyer may consider that as a red flag to a potentially underwater loan. The price verbally communicated by the salesperson ought to be consistent with that reflected in the written agreement.2. Wild penalties
If the repayment penalties seem to be unreasonable, they probably are and may quickly turn a loan upside down. A common method of ascertaining whether the penalties are reasonable is by running a comparison between the rates offered by different dealerships.3. Inclusion of unnecessary add-ons
Wise buyers tend to be wary of what is included in the car purchase. That includes the question of whether the car shall have any fancy gadgets and whether the price is inclusive of the same. When fancy add-ons pop up in the written contract and increase the price of the vehicle to an amount higher that what the buyer had planned for, there is a higher likelihood of it turning into an underwater car loan.Conclusion
In an upside-down loan, the car buyer purchases a car on credit but ends up paying, or owing, more than the value of the car. How to not be upside down on a car loan requires a proactive approach by a buyer. That includes:- Conducting due diligence and research on the price of the car
- Ascertaining that the terms of the agreement correspond to what was agreed on, especially regarding pricing.
- Putting down a substantial down payment on the car and committing to shorter loan repayment terms.
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