Upside Down Auto Loans: When You Owe Far More Than Your Car Is Worth

by Gary Foreman

A seriously upside down auto loan could mean big financial trouble. Find out how to get right-side up again and avoid overbuying in the future.

Dear Dollar Stretcher,
We bought a used SUV with a $840 monthly payment that we can no longer afford. We had a dual income when we bought it, but circumstances changed. We still owe $26,000 on it and it is worth about $13,000.

Is there any way at all to trade to a used minivan and make payments in the neighborhood of $500 a month? I think we still have three more years of payments.
Violet

The Problem Can Be Painful

When you owe more than your vehicle is worth, it is referred to as an “upside down” loan, and the dealer and lender holds most of the cards. They know that you’d have a hard time selling your car “by owner” since that would require coming up with a lot of money.

Plus, the lender is going to want a higher interest rate on the new loan. That’s because the loan is for more than the car is worth. If they did have to repossess, they would be far short of the outstanding loan balance.

Finally, the extra debt means that you’ll be upside-down for a longer period of time in your new vehicle.

Auto Loans Have Changed To Mask the Problem

The trend over the last decade is longer and longer loans. According to the most recent figures from LendingTree.com, the average used car loan length is now 67.6 and the average used car payment is $533. The average new car loan is $726 for 68.3 months. It’s no wonder some people are severely upside down on their car loans.

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Rolling the Current Loan Into the Loan on Another Car

So, let’s look at Violet’s situation. She’s big-time upside down in her vehicle and owes about $13,000 more than it is worth. Plus, she’s struggling with the hefty monthly payments. And she’d like to get into something less expensive, like a minivan.

Could she trade for a used minivan and roll the unpaid $13,000 onto her new loan? Not very likely. At least not with a reasonable payment.

Suppose that she found a $20,000 minivan. She’d be financing $33,000. The van will lose approximately 35% in the first two years (source: Bankrate.com). So, two years from now, the finance company is going to have a $13,000 van as collateral for a $30,000 loan! They won’t do that even at a higher rate of interest. The risk is simply too great.

Violet has gone beyond the point where she can reasonably roll the balance onto a new loan. And, even if she could find financing, she’d be upside-down in her minivan until it rusted away!

One possibility would be to find a new car that offers a significant rebate. That would help but still puts her in a position of being upside down in her new car for many years.

Getting Current Loan Payments Reduced

Can Violet reduce her payment? To do that, she’d need to lower her interest rate or increase the length of the loan or both.

In Violet’s case, she’s probably not going to get a lower interest rate. In part, because only half of the loan is collateralized (i.e., the vehicle is only worth half the amount that’s owed on it).

But she might be able to extend the life of the loan. If she were to go to six years, the payment would drop to $481 per month. The best way to do that is to approach her current lender. They might let her do that for two reasons. They’ll collect twice as much in interest and they don’t want to repossess Violet’s SUV and take the loss.

A second possible solution would be to use a different source to raise money to pay off the vehicle loan. Two possibilities are either a homeowner’s line of credit or a 401k loan.

In both cases, she’ll probably get a lower rate than her current interest rate. She’ll also be able to extend the loan beyond the current three-year period, which will also lower her payments. Before borrowing against her home or her 401k, Violet needs to learn more about those types of loans so she understands the risks involved.

What Can We All Learn From Violet’s Experience?

We can all learn a number of valuable lessons from Violet’s experience.

Longer auto loans can be dangerous because circumstances change. New car loans can last up to 84 months. No one can reasonably predict job, health and family circumstances seven years into the future.
Car payments that are too high for your budget can be very expensive. If you struggle to make the car payments, you’ll probably shift other expenses to your credit card. And that can be very expensive debt. Up to 30%!
Rolling over debt from your current vehicle onto your next car is dangerous, especially if it’s more than about 10% of your new car price.

Hopefully, Violet will be able to ride out this rough stretch of road and will stay right-side-up in future vehicles.

About the Author

Gary Foreman is the former owner and editor of The Dollar Stretcher. He's the author of How to Conquer Debt No Matter How Much You Have and has been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report, US News Money, Credit.com and CreditCards.com.