With very, very few exceptions, a car is a depreciating asset. By the time the ink is dry on a car loan agreement, the car is worth less than what you paid for it.
The thing is, most people who buy a new car need a loan to do it. Unfortunately, a loan for the car’s full purchase price, plus interest, means that car buyers generally owe more (sometimes much more) than the car is worth. This is what we mean by “underwater” or “upside down.” In order to sell the car, the loan has to be paid off in full, but in order to pay off the loan, more money needs to be found somewhere.
This is a common situation, and having negative equity in a new car is not always as bad as it sounds. Over the first few years of ownership, the loan balance and the car’s fair market value will usually find some sort of equilibrium, meaning that the owner can, at some point, sell the car for an amount that will pay off the loan. That’s the easiest way out of an upside-down car, and it’s the best solution for people who can be patient. Paying a little extra each month, if possible, will help.
Still, waiting to sell won’t work for everyone. First, this plan assumes you can wait until the ideal time to sell the car, and that’s not always the case — you might need a different car to start a family, to change jobs, to move, or to simply drive something less expensive. And second, waiting a little while longer won’t work as well if the loan terms aren’t conventional. If the interest rate is extremely high, then it’s likely that a lot of the car’s principal balance still needs to be paid off, because too much of the payments went to paying interest instead of paying down the amount that was actually borrowed.
Also, if you bought the car with a very long loan term, like one of the five- to seven-year terms that are growing in popularity it’ll take a long time before the loan principal’s paid down to the car’s value. That’s because though you pay less money each month, each payment doesn’t go very far toward paying down the debt.
Finally, if you rolled an old underwater car loan into the current loan, it’ll be almost impossible to sell the car until the loan is fully paid off, because there will be a massive difference between the loan balance and the car’s value. Though some car salesmen might try to convince you that this is a normal thing to do, just to make a sale, rolling negative equity from one car into a new car loan a terrible financial decision. It essentially adds the old debt to the purchase price of the new car, plus interest, and causes a cycle of debt that’s very difficult to escape.
If you need to sell a car you’re upside down on and you just can’t wait, you have a few options. You can pay cash out-of-pocket to make up the difference, although someone in this situation might not have that kind of cash available.
Some banks and credit unions will be willing to issue a new personal loan for the difference between the car’s sale price and the loan balance. This means more debt, however, and will require a decent credit score, because the collateral that originally secured the car loan — that is, the car — will be gone. If you go this route, commit to paying off the new personal loan as quickly as possible, because basically, you’re still paying for a car you can no longer use.
Another option is called a “voluntary surrender.” In this case, you talk to the financial institution holding the loan (whether a bank, a credit union, or the dealership’s own financial division) and explain that you can’t afford the car payments anymore. Downsides of this approach are that it’s expensive, both immediately and in the future. A voluntary surrender often carries fines or fees, which should be explained in the original loan paperwork, and it will damage your credit report, similar to if the car was involuntarily repossessed. There is an advantage, though: a voluntary surrender avoids the hassle of actually selling the car, since the keys are handed over to the bank.
There’s still one problem for people who sell an upside-down car — none of the solutions discussed will really help you replace the car in question (with the exception of rolling the debt into a new car loan, which is, regardless, still a bad idea). Once the upside-down car is sold, there’s no more car, and if you still need a car to get around you’ll have to start all over. On the upside, the experience of getting rid of an underwater car should encourage better financial habits in the future.