How to get out of a reverse car loan

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  • When you’re upside down on your car loan, you owe more money on your vehicle than it’s worth.
  • Small down payments and long loan terms make it easier to get your loan upside down.
  • Consider refinancing your car loan or contributing more money per month to reduce negative equity.
  • Learn more about Personal Finance Insider loan coverage here.

Since most cars lose value quickly after purchase, your car loan could be upset. Fortunately, there are options to help you get out of this financial burden.

What is a reverse auto loan?

When you’re upside down on your car loan, you owe more money on your car than it’s worth.

Let’s say you took out a $20,000 car loan with a term of five years and an interest rate of 5%. However, the value of your car will depreciate as soon as you leave the lot. After two years, you still owe about $12,000 on your loan, but your car is only worth $10,000. This means you are upside down, also called having negative equity, by $2,000.

If you want to get rid of your car, you must pay the lender the negative equity in the vehicle in addition to the amount you are selling or trading it for.

Rolling over your loan is not a bad thing in itself, but it can cause problems if you find yourself in certain situations.

For example, if your car is totaled, your insurance company will only pay the estimated value of your car. If you are upside down on your loan, you will owe the lender your negative principal, which could be thousands of dollars out of your pocket. Or say you want to switch from your current car to another. You will need to pay the amount you owe plus the trade-in value of your original car to trade it in.

How do reverse loans happen?

Reverse loans are often the result of the terms you choose when you buy your car. Here are some of the most common reasons.

  • Little or no money down. Cars lose a percentage of their value almost immediately when you drive them off the lot, and if you don’t make a down payment, you can instantly be upside down on your loan. With no down payment, you’ll also end up financing taxes, licensing, registration and dealership fees, which will add to the total cost of the loan and already leave you with more than the value of the car.
  • Long term loans. Dealerships can offer terms of up to eight years, but your payments might not be able to keep up with the depreciation. The longer the term, the more money you will pay in interest. Keep in mind that shorter terms come with higher monthly payments.
  • Overpriced cars. Do your research on similar makes and models and shop around at different dealerships to find the best deal possible. If you jump on the first offer you find, it could end up costing you thousands of dollars in the long run and hastening your loan rollover.
  • Unnecessary supplements. The dealer might pressure you to buy things like extended warranties, sunroofs, or DVD players because they make a lot of money on those add-ons. However, each additional purchase you make means you will have less money to spend on the car.

How to get out of a reverse loan?

Start by determining how much you owe on your car. To calculate this figure, subtract the value of your car from the outstanding balance of your loan. The Federal Trade Commission recommends consulting the National Automobile Dealers Association, Edmunds, and Kelley Blue Book guides to estimate the current value of your car.

Then you can consider refinancing your car loan. You may qualify for a lower rate and shorter repayment term when you refinance, reducing the time it takes to get out of negative equity in your loan.

If you have enough money, you may want to pay off your negative principal in one lump sum, but check with your lender to make sure you won’t incur any prepayment penalties. You probably don’t want to completely empty your bank account to do this, as you’ll want to have cash on hand in case of an emergency.

You can also contribute more per month by rounding your payments to the nearest $50, for example. You will repay your loan and get rid of your negative equity faster.

Discover our tips for repaying your car loan faster.

Selling your car privately through marketplaces like Craigslist or Ebay is another option to consider. You should try to get enough money for the car to clear your negative equity, otherwise you will have to pay that money back yourself.

Finally, you can think about trading in your car at the dealership, but be careful before doing so. If you’re not careful, you could immediately end up with negative equity on your new car and fall into a debt cycle. However, you could potentially be safe from your negative equity if you can downgrade and find a car that’s worth more than its price.

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