CCC010: What to do With an Underwater Car Loan

I went out and reviewed my Google Analytics stats for my website,, and found that the number one search bringing people to my site had to do with some combination of words having to do with an underwater loan. I was surprised by this given I had only written one article on this subject. Evidently many people have questions about this topic.

I therefore decided to do this podcast episode.

I even received an e-mail from a listener this week who was $10,000 underwater on his car. On top of this, I spoke to three people this week who either were currently or have been in car loans that were underwater.

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Seventy percent of people buy cars on credit today. The result is many people find themselves in some kind of car loan trouble. Many with a car loan that is underwater. You may also hear this called being upside down or having negative equity. Let’s take a look at what being underwater is and how it can happen. An underwater car loan is one in which the loan balance is more than the current value of the car.

An example is you may owe $20,000 on a car worth $18,000. This would mean you have negative equity of $2,000 on this loan. This is being underwater. Ultimately meaning if you sold the car for what it is worth you would owe $2,000.

How can this happen you might ask?

Let’s start with new car prices continuing to go up while median income has fallen. Both and show new car prices over $31,000 in the month of August. This is up from just over $28,000 in 2009, as sited in an article by the Detroit Free Press.

While the mean income in the U.S. has gone from $54,500, in June 2009, to $52,100, in June 2013, according to an August article in the New York Times.

Between 2009 and today, median income is down almost 5% while new car prices are up nearly 11%. These numbers create a problem for the auto and lending industries as well as consumers wanting to buy a new car.

How can more expensive cars be sold to people with less money?

The answer, by lengthening the loan term for new car financing. By doing this it will keep new car payments from going beyond a buyer’s ability to pay. People who believe they will always have car payments tend to focus on the car payment as the sole definition of affordability.

According to the Wall Street Journal, 17% of all new car loans in the first quarter of 2013 were between 73 and 84 months. In 2009, only 11% of loans fell into this category. The result, more people financing larger amounts over a longer period. This has led to more car loans being underwater.

Another dangerous tend in these loans is that they are being made to subprime borrowers. Consumer Reports sights average credit scores for new car purchases have dropped twenty points to 755. Used car buyers average credit scores have dropped 18 points to 668.

They further sighted in 2011 38% of all used cars and 13% of new cars are purchased by subprime borrowers.

The loan to value ratio for these subprime borrowers currently stands at 114.5% up from 112% in 2010, according to Bloomberg. This means these borrowers owe 14.5% more than their car is worth.

They also found that with low interest rates and 10% down it can take two years or more to begin building equity in a new car.

I used new car purchases to illustrate how people have gotten in to underwater car loans, but similar factors exist in the used car market as well. Since used cars have already lost much of their value in the first few years, this is less of an issue.

Underwater car loans can also be created by rolling negative equity from a previous car purchase into the purchase of ones current car. This happens quite often when people are trading up after having owned a car for a short period of time.

There are other ways an underwater car loan situation can be created, but I think I have given enough examples to explain being underwater and how people can find themselves in this position.

If you find yourself in an underwater car loan situation, what can you do?

1. Keep making the payments.

If you can afford to do so, continue to make the payments.

Make the payments until you pay your car off. You are now driving a cash car. You can then save the car payments you were making to buy you next car.

Alternatively, you can continue to make payments and drive the car until you can get to a positive equity position. You would want to continue making payments until you have enough equity to buy your first cash car. You can then sell your debt laden car. The benefit of this alternative strategy is it allows you to get to a cash car more quickly.

2. Take out a personal loan and sell the underwater car.

This option requires you take out a loan for the amount you owe over and above the car’s sale price. This can be done in one of two ways.

The first, is to go to the financing company for your car and see if they will agree to allow you to take out a personal loan for the difference between the sales price and the amount financed.

The second, is to go to your local credit union or bank and secure a personal loan for the difference between the car’s value and loan payoff.

Regardless of which option you choose, be sure you secure an agreement for this financing before you sell your car. You will need to pay off your current car loan when you sell your car.

The benefit of selling versus trading in is selling will allow you to close more of the negative equity gap.

A quick personal story to illustrate the point. I have never traded a car in, but tried to once. I had a car that was quite old and I didn’t think there would be much difference. The dealership offered me $600 for the car. I had researched the car’s value and knew the trade in value was $1500. I rejected their offer and their car. I sold my car for $2800 and bought somewhere else.

With your underwater car sold, you can now focus on getting a more affordable car to drive. As you likely haven’t been able to save enough for a cash car you will still need to buy a car using credit however.

3. Trade down and roll the negative equity into the new loan.

For this option, let’s assume you have a $25,000 loan and your car is worth $23,000 if you sold it. Let’s say you find a used car you like for $12,000. If you can trade in your existing car for $21,000 and finance the additional $4,000 on the used car. The new loan on the used car worth $12,000 would be $16,000.

You might be saying what is the benefit, I am still upside down and even more in the hole. The benefit is you were in a loan of $25,000 and now you are in a loan of $16,000. You just eliminated $9,000 in auto debt. Another benefit maybe a lower monthly payment depending on the financing on the current car and financing on the used car.

I will be the first to say this is not an ideal solution. It is, however, another option to consider. You maybe having trouble making your payments. You may want to eliminate as much auto debt as you can as quickly as possible.

4. Voluntary Repossession

If none of the other options work for you, you may be forced to do a voluntary repossession to get out from under the car loan.

This will damage your credit for years to come and you will still be obligated to repay the difference between what the car sells for at auction and the amount you owed on the loan.

If you don’t repay this obligation, a lawsuit will be filed and judgement will be entered against you.

While I am not big on credit, I am big on personable responsibility. Repay the amount you owe. You signed the original note and legitimately owe the money.

If you are underwater on your current car, you have my sympathy. I haven’t had this happen to me, but I have been in a situation where I needed to sale a car but couldn’t. Feeling trapped is an awful feeling. You now know you have options.

I hope one or more of the options will help you get out of your underwater car. It will be a step in the right direction. A step towards a cash car and getting control of your financial future.


Dave Ramsey – How to Sell an Underwater Care:

KBB – Upside-down on a Loan?:

Banking My Way – Can You Renegotiate Your Auto Loan?:

WikiHow – How to Get Out of a Car Loan:

Ready for Zero – Help, I Owe More Than My Car is Worth: What To Do When Your Car Loan Is Underwater:

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