It’s financially frustrating to owe more on your car loan than the car is worth — what’s referred to as being upside-down in your loan.
Unfortunately, it’s fairly common to end up being upside-down in your car loan, at least for a little while — especially if you finance a new car since new cars start losing value the moment they’re driven. However, many missteps that cause car buyers to wind up owing more than the car is worth happen well before they step onto the lot to hear the sales pitch.
The last thing we want is for you to find yourself in this situation. Explore these 7 tips before you go car shopping to help stay in a solid financial position for the life of your auto loan.
7 Tips to Avoid Getting Upside-Down in Your Auto Loan
1. When possible, buy used.
Customers who buy a new car will usually be upside-down in the loan, at least for a couple of years, unless they shell out a significant down payment. Buying a quality, well-maintained used car, on the other hand, can help you avoid getting upside-down in your loan.
2. Shop around for the lowest rate.
Of course, if you’re paying high interest rates every month, you aren’t paying as much toward principal reduction, and it will end up taking you longer to get right-side up in your loan. That’s why we recommend “shopping for your money” before you go shopping for your next new or used car. Getting new or used car financing at the dealership will rarely get you the best interest rate.
3. Choose the shortest loan term possible.
Other than buying used, this may be the best advice for staying right-side up in your car loan, particularly if you are buying a new car. Too many dealerships these days offer long-term car loans of 60 months or more. While the lower monthly payment can be tempting, extending the length of your loan causes you to pay more in interest and makes it take even longer until you are right-side up in your new car loan. In addition, if you decide to trade-in your car while you still owe more than it’s worth, you will either have to pay cash to get out of the loan or roll the payoff amount into your financing, putting you even further behind on your next car. Ideally, you should choose a loan term that matches, or is less than, the number of years you plan to keep the car. Make the choice now to stay on top of your car loan, and use our convenient online auto loan calculator to see how much you can really afford.
4. Make a down payment.
Whether you are buying a new car or a used car, it makes financial sense to put as much money into a down payment as you can. When buying new, a down payment can reduce the amount of time that you are upside-down in your loan and, when buying used, it will reduce the overall cost of financing. Financial experts recommend putting down at least 20% of the price of the car — but don’t think you have to bring that much in cash. Manufacturer cash back rebates and any value you have in your trade-in will count toward your down payment. Even if you can’t scrape together 20%, putting even $500 down may help you avoid getting upside-down in your loan.
5. Know what your trade-in is worth.
When shopping for your next car, you have to be your own financial advocate. Never walk into the dealership blind. Before you go, make sure that you know the NADA value for your used car so that you know what your trade-in is actually worth. Include any factory extras and be fair about the condition your car is in. Having well-documented maintenance records can help you establish the condition of your car as well. Remember, the trade-in value counts toward your down payment, so you want to get every dollar that you’re entitled to.
6. Choose a car that retains its value.
Some cars hold their value better than others. While most of our tips focus on lowering the cost of your car financing, you can also avoid getting upside-down in your car loan by raising the value of the car that you purchase. Purchasing a car that depreciates more slowly will shorten the length of time you are upside-down in your loan. Consult an independent car fact website such as NADA for average depreciation rates and make sure to add depreciation to your list of considerations when shopping for your next car.
7. Watch out for "free" extras.
Buy a new car and get a free flat panel television! Buy a new car and get a trip for two thrown into the bargain! If promotions like these sound too good to be true, they probably are. While some promotions are legitimate, many of these freebies are actually rolled into the overall financing, putting you further behind in your loan from day one. Be sure to read the fine print carefully and say no to free offers that could end up costing you a lot down the road.
This material is for educational purposes only and is not intended to provide specific advice or recommendations for any individual.