UPSIDE DOWN CAR LOAN
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| An upside-down car loan is the less onerous euphemism for saying that
you owe more on your car than you could get if you sold it
or traded it in. Is this a bad thing? And what, if anything,
can you do about it? |
If you put ten people who have bought a new car in the
last couple years in a room, chances are that four of them
are upside-down on their car loans.
Owing more on your car that it is worth is not necessarily a
bad thing if you intend to keep the car until it's paid off,
and you have the auto insurance coverage to satisfy the loan
if the car gets totaled in an accident. Doing nothing is
always an option.
If you are looking to replace the car then you have to do
something to close the gap in the unpaid balance of your
current loan and the car's resale value, or be prepared to
eat the difference and go even deeper upside-down on your
next car purchase.
Some new car lenders will add the amount of the unpaid
principal on your old loan to the principal amount on your
new car loan. In effect you would be paying that much more
for your new car, or still paying for the old car you no
longer own, which ever way you want to look at it. Do that a
couple times and you've paid for somebody else's Hawaii
vacation.
If your current car loan contract doesn't have a prepayment
penalty, you can refinance your current car loan.
Refinancing home mortgages to get a better APR is a national
pastime but not nearly as many people have done the same
with the second most expensive thing they own. Interest
rates change all the time and it may be worthwhile to
investigate 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 too.
Another option is to pay your current lender extra every
month. This can close the gap in a hurry but only if your
lender has agreed ahead of time that all the extra money you
send will go to 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 most likely
just credit the extra toward a future payment. There is no
advantage to you paying extra unless the principal portion
of your car loan is being reduced proportionately.
Pay off the car loan with a real estate equity loan or a
loan from another source. The main advantage to this
approach is that you go instantly from upside-down on the
car to 100% ownership. You can now sell the car yourself to
raise cash for a substantial down payment, or you can trade
it in toward the new car.
Car loan amortizations are set up so that the money from
most of your early payments goes almost entirely to the
interest portion of the loan. During the first two years of
the loan, the resale value of the car plummets while the
principal portion of the loan barely budges. The sooner in
the loan cycle you address your upside-down loan the better
off you will be.
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