If you put ten people in a room who have bought a new car in the last few years, chances are that four of them are upside-down on their car loans.
When someone owes more on their car than they could ever get for it if they sold it or traded it in, this is called an upside-down car loan. Is this something bad? And what, if anything, can the four people who are upside down do about it?
If you plan to keep the car until it's paid off and have auto insurance that will cover the loan if the car is totaled in an accident, owing more than the car is worth isn't always a bad thing. You can always choose to do nothing.
If you want to buy a new car, you need to do something to close the gap between the unpaid balance of your current loan and the car's resale value. If you don't, you'll have to eat the difference and buy your next car even further underwater.
Some lenders for a new car will add the amount of your old loan's unpaid principal to the amount of your new loan's principal. In the end, you would either have to pay that much more for your new car or keep paying for the old car you no longer own. If you do that a few times, you'll have paid for someone else's trip to Hawaii.
You can refinance your current car loan if you don't have to pay a fee for paying it off early. Refinancing home mortgages to get a better APR is a national pastime, but not nearly as many people have done the same thing with the second most expensive thing they own. Interest rates are always changing, so it might be a good idea to look into this route. Even if you refinanced at the same rate for a shorter term, your monthly payment would be higher, but you would get out of the negative equity situation faster.
Every month, pay more to your current lender. This can close the gap quickly, but only if your lender agrees ahead of time that all the extra money you send will go toward paying down the principal balance on the loan. If you just add something extra to your loan payment without working it out first, the lender will probably just put the extra money toward a future payment. There's no point in paying more on your car loan unless the amount you owe on the principal goes down at the same rate.
Pay off the car loan with a loan against the value of your home or another loan. The main benefit of this method is that you go from being upside down on the car to owning it right away. You can now either sell the car yourself to get enough money for a big down payment or trade it in toward the new car.
The way car loans are amortised is set up so that almost all of the money from your early payments goes toward the interest. During the first two years of the loan, the car's resale value drops while the amount owed on the loan doesn't change much. The sooner you deal with an upside-down loan, the better it will be for you.
