Do You Have an underwater Car Loan?

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As the title of my website indicates I advocate driving a car purchased with cash. I believe this gives individuals an opportunity to prioritize their spending. The focus can then be on their financial future rather than living for the car of the day.

Having said that, I know I am in the minority. Most  people buy cars on credit. The result is many people find themselves in a car loan that is underwater. You may also hear this being called 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 owe $20,000 on a car worth $18,000 you would have negative equity of $2,000. This is being underwater. 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 wages have fallen. Both Truecar.com and KBB.com 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 salary 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, wages are 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 could 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.

I have utilized new car purchases to illustrate how people have gotten in to underwater car loans, but similar factors exist in the used car market too. Since used cars have already lost much of their value in the first few years, however, 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.

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.

What car issues are keeping you up at night? Let me know and I will try to address it in a future post.

Question: What is keeping you from buying a cash car? If you already drive a cash car. How did you get the money to purchase it.

Please note: I reserve the right to delete comments that are offensive or off-topic.

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4 thoughts on “Do You Have an underwater Car Loan?

  1. Thank you very much for this article! This is exactly what I’ve been looking for. I’m not wanting to trade my car for financial reasons. I am going to be relocating and my commute to work is going to be longer. So, instead of driving my 15mpg suv, I’m looking to get a more fuel efficient vehicle. But, I just bought my 15mpg suv a year ago. I was wondering about the option of a trade in, then purchase a less expensive vehicle, because sticking it out, really is not an option, I don’t believe. I’d getting murdered on gas. This article explained exactly what I was looking for.

    • Hi Marcus!

      While I would like to see you in a cash car, if you can trade down to a cheaper car it will get you closer to your cash car. In this case, you can also get a car with better gas milage.

      If it were me, I would sell the 15mpg SUV myself. This would allow me to get the most for the SUV. I would then be able to buy the next car. Hopefully with cash, but at least something that gets me closer to that result.

      For example, if you SUV cost $30,000 and you get a car for $15,000. You just dumped $15,000 of debt.

      Let me know what you decide and what the outcome is.

      Best wishes.

  2. My sister pays $425 on a 2006 infinity g35 but would like to get 2008 G35 with more bells and whistles. The new car is the same as her payout of 14k. Her car is kbb valued at 9k which leaves 5k underwater. What should she do and what should she expect. Thanks

    • Hi Rodney, thanks for the comment. Your sister is in a tough spot.

      I am going to be candid, because to sugar coat the message would do her no good.

      The first thing I would say is if you find yourself in a hole, stop digging. Your sister is in a hole and it is about to get deeper.

      If your sister trades up now, she will only find herself more upside down, or with more negative equity, than she already is. The dealer may allow her to trade up, but would likely roll her negative equity into the transaction. Instead of having $5,000 of negative equity, she might have $6,000-$7,000 of negative equity. This is a path she doesn’t want to get on.

      I’m not sure how your sister got so upside down on a 2006 model car, but she should plan to keep this car until either the lease is up or until she can at least break even on disposing of it. I fear she may have gotten upside down by having rolled some negative equity into her current car. Otherwise, I’m not sure how she could be so upside down on a car this old.

      The other thing that comes to mind is, I’m assuming the $5,000 negative equity is based on a trade in price and not a private seller price on KBB. If that is the case, is there a way your sister could sell her current leased car on a site like swaplease.com and close the gap enough on the negative equity to get out of the car. If so, maybe she can scrap together enough money to buy an inexpensive car with cash.

      Once out of the $425 per month car, she could find something cheaper and save her $425 for her a car purchased with cash. This will get her off the car payment merry-go-round.

      This is not an easy solution, but it will only hurt once. If she continues to make payments, it will cost her a million dollars over her lifetime.

      $425 x 12 months = $5,100 per year

      $5,100 x 40 years = $204,000 over her lifetime (straight saving with no interest)

      $425 per month invested at 8% interest for 40 years is $1,493,569.52.

      That means $1,289,569.52 is interest or her money working for her. Amazing, right!

      This is what your sister needs to know.

      If she changed nothing else in her lifestyle, she would still be a millionaire in 40 years by just driving a car bought with cash.

      Short term pain, long term gain.

      I hope this helps.

      Please e-mail me at james@cashcarconvert.com for further discussion of her situation.