A reverse auto loan is a loan in which the driver owes more than the actual value of the vehicle. In order to avoid being upset on your loan, or at least to minimize the time you spend in this precarious financial situation, you may need to make additional payments or adjust your coverage. Here is what you need to know
What is a reverse auto loan?
A car loan becomes topsy-turvy when you owe more on the loan than the value of the vehicle. For example, your loan would be reversed if the value of your SUV is $ 12,000 but your loan balance is $ 15,000. In this scenario, you have negative equity of $ 3,000.
Being upside down isn’t always a problem, but it can make some things more difficult. For example, if you want to trade in your vehicle, you will have to pay this negative equity. The same is true if your car is totaled. In addition, having negative equity can make it more difficult to obtain a future car loan with reasonable rates.
That said, if you plan to pay off your car loan in full, being upside down isn’t a problem – if you make all of your payments, you’ll gain equity over time.
How you ended up with a loan backwards
It is not difficult to find yourself in a reverse auto loan situation. Perhaps you financed the vehicle without a down payment; although this may be the most financially viable option for you, vehicles can lose up to 20 percent of their value in the first year of possession. Therefore, it won’t take long for your vehicle’s depreciation to exceed your equity, even if you made your payments on time.
Another way for people to end up with a reverse loan is to take out a car loan with a longer repayment term. Some lenders allow borrowers to finance new cars for up to 84 months (or seven years), so your car may have depreciated beyond your original point of purchase by the end of that period.
Keep in mind that in the first few years of the loan, more of your payment is spent on interest rather than building equity in the vehicle. Likewise, the higher the interest rate you pay, the more interest you will pay to the lender and the less it will be used to repay the principal of the car loan.
How to tell if your auto credit is upside down
While being upside down on your loan isn’t always bad, you need to be aware of it. You can determine if you have negative equity by doing a little research on your loan and vehicle:
- Receive a refund quote: A reimbursement quote is a document that shows exactly how much you currently owe on your vehicle, including interest charges. You can request this from your lender.
- Know how much your car is worth: Kelley Blue Book’s car value calculator gives you a low estimate of the value of your vehicle if you decide to trade it in. However, a private sale value may result in a higher price for the car.
- Do the math: Subtract your loan balance from the value of your car to determine your equity. If the number is negative, you are upside down on your loan.
Tips for getting out of a reverse loan
If you ever want to sell or trade in your vehicle, it is easier to do so if your loan is not upside down. Here are some ways to reduce negative equity in your car:
- Make additional payments: Making an additional payment each month will help you build equity faster, especially if your additional payments are used entirely towards the principal amount of the loan.
- Refund: If you plan to keep your vehicle, continuing to make payments until the loan is paid off will eventually result in positive equity. The remaining equity in the car at the end of your term can be turned into cash through a sale or exchange.
- Purchase gap insurance: Gap insurance bridges the gap (as a percentage) between what your insurance company pays for the vehicle and what you owe on the loan, which helps lower your bill if your car is totaled.
- Refinancing: Refinancing your loan for a shorter term or at a lower interest rate will ensure that more of your payments go to your principal, which will help you catch up with your principal faster.
How to Avoid Getting a Reverse Car Loan in the Future
When you take out a new car loan, these steps can help you avoid getting underwater:
- Plan to pay taxes and fees up front: The rollover of taxes and fees in your loan automatically turns you upside down, since you will be financing more than the value of the car.
- Make a deposit: Since depreciation occurs most quickly in the first year of a new car, paying a down payment can make up for how long you’ll be upside down. Try to reduce the total cost of the car, including taxes and fees, by 20%. Whenever possible, take advantage of the manufacturer’s cash back rebates and any trade-in value of your old car.
- Choose an appropriate loan term: If you can afford it, choose a loan term equal to the time you plan to keep the car. If you trade in your car before it’s paid off and you’re upside down, you’ll either have to pay the difference in cash or the repayment amount will go into your next loan. This will automatically put you even more upside down in your next car.
- Choose a slow-damping vehicle: Different brands of cars hold their value better than others, and choosing a car that will depreciate more slowly will reduce the length of time you’re upside down in the car loan. As you research which car to buy, take a look at the ownership costs listed for each car on sites like Kelley Blue Book to see the depreciation differences among your top few choices.
Being upside down on your car loan can be inevitable, especially early in your loan term. However, there are ways to minimize the time you spend upside down. Making additional payments, increasing your down payment, and refinancing are all viable ways to avoid staying upside down and starting to build equity in your vehicle. When shopping, you can use an amortization schedule to estimate how long it will take to go from negative equity to positive equity.