Well, an underwater car loan does sink you in debt. The term “underwater” refers to owing more than your car is worth.
Say you borrowed $25,000 to purchase a car five years ago. You still owe $15,000. But when you looked up the price, it was only worth $9,500. You’re underwater, to the tune of $5,500. Even if you sold your car tomorrow, you wouldn’t get anywhere near what you owe.
More and more car owners owe more than their vehicles are worth. When new car buyers at dealerships offer their current cars for trade-in, 32 percent are underwater. That’s the highest percentage since the number began to be compiled in the early 2000s.
Why are an increasing number of people underwater on vehicle loans? Many factors contribute. Car prices are very expensive. Dealers and other lenders are allowing low or no down payments. Since cars depreciate 20% in price the minute you drive them off the lot, you can be underwater before you get the car home if you don’t have a 20% down payment.
Longer loan terms also play a role. A $25,000 car may leave you making payments for many years. This is especially true if you are a single person. You have less disposable income than a couple, and may have wanted a low monthly payment. That’s great for your monthly budget. Not so great for putting a dent in your car loan.
Car depreciation also plays a role in the rise in underwater car loans. By the third year, your car has lost 50 percent of its value. So your $25,000 car is worth about $12,500 in year three. You may still have about $15,000 to $20,000 left on your loan.
Underwater loans can hamper your ability to save and buy a house or start a family. They can hamper your ability to go eat pizza, for that matter.
So how do you get out of an underwater car loan? Here are four methods.
- Keep Your Car
The most prudent way to get out from an underwater loan is simply to keep your car. Many cars today will keep going past the 100,000-mile mark and beyond quite nicely as long as you keep up the maintenance. At some point, if you are in a fender-bender, you may find the car is worth less than the cost to fix it. But until then, keep on drivin’. Put the loan payments to good use.
- Increase Your Monthly Payments
You can pay down any type of debt faster by increasing the monthly payments. Vehicle loan debt is no exception. Go through your budget and determine if you can hike the payments. If you can double the amount of your payment, it can pay down your debt nicely. But even $25 more per month will help.
- Refinance Your Debt
You may be able to refinance your debt. If you can get a lower interest rate, your payments will be lower. This depends on your lender’s policies on refinancing car loan debt. It’s worth trying, though, especially if your credit score is good to excellent. Credit unions may be the best candidates for this strategy.
- Roll Over Your Loan
Some of those new car buyers with underwater trade-ins may have been rolling over their loans. This requires a lender who will give you a loan for a new vehicle and roll over the outstanding amount from your previous car into that amount. In other words, if you are buying a $25,000 car and have $4,000 still outstanding, your total loan is $29,000.
- Sell Your Car and Borrow the Difference
This is recommended for people whose goal is to decrease their overall debt, not solely to get out from an underwater loan. Say you owe $17,000 on a car now worth $12,000. You’re $5,000 underwater. You sell the car and pay off $12,000 of your car loan. Then you pay down the $5,000. The downside? You will no longer have the car. It is workable if you either don’t need a car or can use another car.
- Borrow on a Credit Card
If you have offers for 0 percent or low-interest rate credit cards, it may be a good idea to borrow the amount you need on the credit card. Then pay off either the underwater amount or the entire car loan with the credit card money. Note that this will only make financial sense if the interest rate on the credit card is less than the one on your vehicle.
It’s no fun being one of the many folks underwater on a car loan. But you are not alone. These steps can get you out of being underwater.
Anum Yoon is a millennial money blogger who runs Current on Currency. You can find her work in various sites across the web, sharing her thoughts and views on money and life.