How to get out of an upside down car loan

I spend a lot of time browsing the personal finance subreddit (/r/personalfinance). There is plenty of bad advice and no shortage of people who pop into threads merely to pat themselves on the back for being better than whoever submitted the post, but there is still a lot of really helpful information posted there and I think most people who post there walk away better off than they were before they posted.

One thing that has always cracked me up a little is how /r/personalfinance talks about cars. Everyone on there HATES cars. No matter how cheap your current car is, there is always a cheaper one out there (that has been only driven to/from church by an old lady) and you need to sell yours and buy it ASAP before your financial world comes crashing down on you. If Jeff Bezos posted on there that he was driving a paid-off 1996 Honda Civic, /r/personalfinance would flog him for not getting a 1992. But, I digress…

The backlash against cars isn’t entirely unwarranted – cars are necessary for many Americans, but they are expensive and people often pay more than they should for more car than they need, and do so under terms that are less than ideal. It kills me to see people posting on there who have a car that should have cost around $15,000, have been paying $400/month on it for 3 years, and still owe $20,000 on it. Yikes. That happens more often than I could have ever imaged before spending time on that subreddit, and it brings us to the topic at hand.

If I’m upside down in my car, how do I get out of it?

Upside down, underwater, negative equity – these all mean that you owe more on your car than it is worth. This happens if you overpay for a car, roll other stuff into the loan, or have less-then-optimal terms (ie, zero down or 6-8 years for the loan). Even if you don’t overpay for your car and put some money down, there is a chance you’re underwater at some point on your loan – by many accounts, 1/3 or more of car loans are currently underwater at any given time.

If you pay your loan off, this isn’t a big deal most of the time – at some point in your loan, you’ll have a car that is worth more than you owe again and everything is fine. But, people often find themselves in unfortunate financial situations (often times greatly contributed to by the car itself) and need to shed the monthly payment.

This is where /r/personalfinance becomes unhelpful and possibly even a little dangerous. If you post a budget breakdown on there and your budget includes a car payment, chances are, one or more people will tell you to sell the car and buy a cheaper one – depending on how bad it is, it may be the #1 overall suggestion. While this may be useful advice in some situations, it is often easier said than done and people driving by in the thread to tell you to do that never stop to find out enough information to know if that is the case or not. Unfortunately, the more dire the situation, the more likely the chances that the person has any good options in this area.

If you are in a happy situation where your car is worth more than you owe, it is indeed quite simple – sell the car, collect a check for whatever equity you had in the car, and buy yourself something more reasonable. What if you owe more than the car is worth? Here are the options:

1) Sell the car to CarMax

CarMax is a national car chain, known for no-haggle prices and for being willing to purchase your car without any sort of commitment to buy one of their cars. This solution is often very heavily suggested to people in this situation, and it is easy and fairly low-risk. However, CarMax is not a charity and will not give you more than your car is worth – indeed, of the 3 options, they’ll usually net you the least.

That said, it certainly doesn’t hurt to get an offer from CarMax – at the very least, it will give you some idea of how other options stack up.

2) Sell the car private party

This route gives you the best opportunity to make the most off your car, thus limiting the damage a little bit. It also means the most work – listing the car, talking to buyers, dealing with flaky people, letting people take your car out for a test drive, etc. If you are in a tough spot financially, this work is often worth it.

It should be noted that one reason a lot of people cite for not going this route is the complication that this will add for the closing step. While coming up with the funds to cover the shortfall might take some work, the actual process of closing out your loan and selling the car to another buyer with their own loan is fairly easy – banks handle this situation all the time, and it isn’t a reason to not go this route.

3) Trade the car into a dealer

Another fairly easy option, especially if you are downgrading your car as part of this process. You’ll have to roll any negative equity into a new loan. There are two problems with this:

First, you are kicking the can down the road, not resolving the problem, and now you’ll have even more negative equity in your new vehicle, perpetuating your problem. This is a valid concern, but is often overblown and misses the point anyway – the negative equity you have is money that is gone and any way you get rid of it is going to cost you. If you’d have to take out a personal loan to make up the difference anyway, this option isn’t any worse than that (and might be a little better rate, too).

The second, and bigger, problem is that you may not be able to roll that much into a new loan. Banks limit how much they’re willing to loan above the value of the car that secures the loan – often to around 120%. So, if you are $5,000 in the hole on a $25,000 car and downgrade to a $10,000 car, you likely wouldn’t be able to make up the full difference this way.

4) Keep paying on the car

Often times this isn’t a terrible option, even if the situation isn’t ideal and people think you should get rid of it. Negative equity is a problem that will go away at some point in the loan lifetime, and trying to get rid of a car that you are upside down turns this problem into an immediate one that often requires a large outlay of cash.

5) Allow the car to be repossessed

If the situation is dire enough, then this may be your last and only option. Voluntary repossession is far preferable to having the bank have to hire a repo firm to do it for them – it’ll just add more onto the amount you owe. Note that giving the car back doesn’t get rid of negative equity or solve all your problems – you’ll still owe money to the bank, plus interest.

No Easy Way Out

There often is no easy way out of a bad car loan that you are upside down on, especially when someone is at the point where they are publicly asking for help to fix a bad financial situation. Advice to “just get rid of the car” is unhelpful without understanding all of the numbers involved – often doing so could make the situation even worse.

The other side of this is understanding how difficult it can be to get out of bad car financing situations – it makes a lot of sense to spend a lot of time on the process of buying a car to make sure you don’t get into situations like this.

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