Upside Down Car Loan

Though it's an intriguing phrase, an upside down car loan is no fun. What to do? Read on.

Do you know what an upside down car loan is? If you have financed a fairly new car, chances are good that you've got one! With the current credit crunch, you may be paying an undeservedly high interest rate. If you've financed a car you paid $20,000 for, that interest is going to take quite a bite out of every payment, particularly at the front end of the loan. If you buy a new car and pay cash, you're still going to take a big hit on depreciation in the first year. When that same vehicle is financed, it doesn't take much to imagine how much more you'll lose through interest.

Here's how the upside down car loan comes into being. The car depreciates faster than you gain equity through the monthly payments. This means that the car is worth less than the payoff in just a year. You paid $20,000, but now your car is only worth $16,000 today, but you still owe $18,000. Unless you've got money to burn, this is an unacceptable loss. So what do you do if you're in this situation?

If you really like your car and want to keep it, make accelerated payments as often as possible. If you can pay $50 more each month than required by the contract, you can gain equity faster and reduce the overall amount of interest. If you can add a substantial extra amount with each payment, you can pay the car off faster than the rate of depreciation. If your credit score is adequate, you might also consider taking out an unsecured loan through your local credit union, for a few thousand dollars. You then turn around and plunk that on your car loan. This way, you turn the upside down car loan beast into a manageable proposition, quick equity and better value. The terms of the credit union loan will assuredly be better than the APR on your current car loan.

One good strategy to avoid the upside down car loan syndrome is to buy a car that is almost new and which has already taken the bulk of the depreciation. The majority percentage of depreciation is taken in the first three years. Therefore, buying a three year old car means you're starting out at a financial advantage. Making accelerated payments is again, a good idea.

If you must buy a new car, here are a few ideas that will help you retain as much value during the life of your loan and avoid the upside down car loan situation. Dealers sometimes offer rebates or, alternatively a lower, more attractive interest rate. Keep in mind that rebates and reduced interest offers are more often than not, attached to a "disadvantaged" vehicle, such as a gas guzzling, heavy duty 4x4. With gas prices being what they are, this may not prove to have much resale value later down the road. However, there are some good rebate deals, too. If you'd planned to put $2000 down and you find a deal with a $2000 rebate, increase your value by taking the rebate and adding the $2000 down as well.

In any case, keep the initial loan amount to a minimum. Shop the interest rates and know your credit score before you shop, to be sure you get the rate you deserve. Make extra payments whenever you can. Even $25 a month extra will reduce the overall interest you pay by hundreds of dollars.

As catchy as the name is, an upside down car loan is not something you want!