In the ideal car buying scenario, the value of your car would always exceed your outstanding loan balance. However, sometimes the opposite can happen and you owe more on your car than your car is actually worth - a situation that's referred to as being upside down on your loan. For example, if your outstanding loan balance is $17,000 and your car is valued at $12,000, then you’re upside down. If you wanted to sell or trade in your car, you’d still have some of your loan balance that you’d have to repay. Or, if you had an accident that totaled your vehicle, your auto insurance provider may not pay out enough money to cover the full balance of the loan.
You can become upside down in your car loan if you have a high interest rate, a long repayment term, or if you’ve missed payments on your loan, but you haven’t completely caught up yet. You don’t want to stay upside down in your loan, especially if you’re thinking about trading or selling your vehicle soon. Having a high loan balance can also affect your credit score, since 30% of your score is based on the amount of debt you’re carrying. Here are some options for turning your car’s value to loan ratio around.
Make sure you have gap insurance. This insurance covers the difference between your car’s value and your loan amount. If you’re in an accident and your vehicle is totaled, gap insurance will take care of the difference.
Make extra payments. The more you can pay towards the loan, the more you can bring the loan’s value down closer to your car’s value. Look to your budget to see where you can cut spending. You can also use any lump sum payments you receive - like a year-end bonus or a tax refund - to pay down your loan. Even if you can’t make a full extra payment, paying a little extra each month can reduce your loan balance.
Make sure you indicate that extra payments should go toward the principle. Otherwise, the additional payment will simply be applied to your next payment rather than reduce your balance.
If you’re planning to trade in your vehicle, the lender may allow you to rollover the upside balance into a new loan, but it sets you up to be upside down in the new loan as well. This increases the amount you have to borrow as well as your monthly payment and overall loan cost. Before you trade-in your vehicle, pay down your current loan balance or save up a large down payment so you can reduce the likelihood of being upside down again.