If you’re trying to reduce the payments you have to make each month, you may have looked into refinancing your car or your home. Your lender may have looked at your numbers and had to decline your request because you were upside down on the loan. What does that mean?
What it means to be upside-down
If you owe more than the item is currently worth, you’re upside down. According to Lantern by SoFi, “To say you are upside down on a car loan means that your car is worth less than the remaining amount you owe on the loan. It’s part of auto loan terminology that it can be helpful to know if you’re trying to refinance. You might also hear this called being underwater on the loan.” If you have a mortgage on a house, you may monitor what the value of your home is worth; tax valuations will generally go up and never drop, while real estate valuations can bounce around quite a bit.
However, car valuations generally drop at a pretty steady rate. If you bought a new car and got terms longer than 60 months, you may have found it easier to make the payments, but you probably didn’t keep the balance under the vehicle valuation.
Why it is risky
No matter the collateral, upside down loans are risky both for the owner of the item and the lender. Even if you have full coverage on your vehicle, you can still be in a wreck that totals the car. In this event, the full insurance payout goes to the lender. In addition, you may have a remaining balance on that debt that is due immediately before you can get a loan for another vehicle.
How to Get Out of an Upside-Down Car Loan
If you find out that you have a negative balance on your car loan, there are steps you can take to wipe out the damage. You can
- just keep driving, making the
- getting GAP coverage to reduce the risk of loss in a wreck
- make a sizable payment to catch up
- refinance for a shorter term and larger payments with the same lender
If possible, avoid working with the dealership to get this done. Remember, the dealership needs to gain as much value from your car for themselves as they can get. If that includes your more valuable car, they’re happy with that. The bank wants your payments, not your car.
Tips to avoid
To avoid finding yourself upside down on any loan, do your best to make a down payment. If you can’t make a down payment, try to make the largest loan payment that you can manage. For example, if you get paid every two weeks, you get 26 checks a year. If your budget works well around 24 paychecks, consider putting at least one of those yearly paychecks against your car loan principal.
Once you get close to paying off the car, you may find it easier to redirect funds toward your car loan principal. Once you cross the line between your loan balance and the car value, you can drop the GAP coverage and roll the monthly fees for that onto your loan principal.
Being upside-down on any loan is not an insurmountable problem. However, you will want to get on top of it before it becomes a serious problem, such as when you need to make an insurance claim.