What is an upside down car loan?

By HUB SmartCoverage Team on May 21st, 2024

In today’s economy, many Canadians may find themselves in a position where they are upside down in their car loans.

This means the amount left owing on their loan is more than its present value. In other words, you have negative equity.

Upside down – also known as underwater - almost always refers to customers who finance their vehicle. For example, if you have a truck you owe $20,000 on that the dealership says is only worth $15,000 as a trade-in, you are upside down for $5,000.

When you consider a new vehicle loses 20 per cent of its value by the time you drive it off the lot, it’s easy to see how this can happen when it is financed without a substantial downpayment. If you sell a car with negative equity, it’s not likely you’ll get enough money to cover what you owe.

If you total the vehicle in an accident, insurance only pays the value of the car, regardless of how much you owe, which means you’ll still owe the balance and that makes it more difficult to get a new car.

“The best financial move for people is to buy a car and drive it well past the point where you have it paid off,” said Jessica Caldwell, a senior analyst at Edmunds, an automobile information and resource firm told Debt.org. “Unfortunately, the trend is that less and less people are doing that now.”

How you get upside down

There are many ways you can get upside down including:

Inadequate research: Many people don’t do enough research on cost for similar models. If you buy a car for $35,000 and similar models are selling for $32,000, you are already upside down.
No-money-down loans: The less money you put down on a car, the more upside down you will be.
Long-term loans: Terms of 72 and even 84 months keep monthly payments manageable. But payments stretched out over longer periods, can’t keep pace with vehicle depreciation.
Roll-over loans: Dealers often offer to roll the negative equity on your old vehicle into your new car loan. This means you’re paying more than what the new one is worth from the start.
Unnecessary options: The more options, the more the vehicle costs.
Expensive car: Buying one that’s too expensive will compete with other necessary payments, like housing and food.
High-interest loans: It’s best to plan your financing before you go to the dealership.

Ways to get out of an upside down loan

The first step is to calculate what you owe. Find out the value of your car using the Canadian Black Book or a site like Carfax.ca, which both have online calculators that determine value using model, year, condition and mileage. Compare different sources and be honest about your vehicle’s condition.

Next, check your loan account online to find out what you owe. Then subtract the vehicle’s estimated value. That’s your negative equity. Once you know the figure, here are options to get out of an upside down car loan:

Keep making payments: If you are not looking to sell or trade in your vehicle soon, making payments is the most straightforward way. It will chip away at what you owe. Making additional and lump sum payments can make this happen faster.

If you are looking to get out of an underwater car loan more quickly, you can:

Refinance Your Vehicle – Depending on currents interest rates, refinancing may help you pay down your balance faster.

Sell Your Vehicle – By selling your vehicle and taking out a loan for the balance owed this can help you to better manage your finances. If selling privately, you may also be able to get more for your vehicle.

Voluntary Surrender – If you can’t make the payments the last resort is to voluntarily surrender the vehicle to the lender at an agreed-upon date. Once the lender sells it, you will receive a statement that shows how much of the debt has been paid off and what the loan shortfall is. That becomes an unsecured loan that you are responsible for. It’s important to note this will impact your credit rating and make it harder to get loans, credit cards in the future.

Tips for avoiding an upside down loan

Use the following strategies to avoid an upside-down car loan:

Pay taxes and fees upfront, not rolled into the loan.
Choose the shortest repayment term you can afford.
Buy a used car, instead of new.
Make a down payment of at least 20 per cent of the vehicle’s value.
Lease if you’ll keep the car for less than three years.(Note: Beware of extra mileage charges)
Get pre-approved for a loan.
Avoid unnecessary ad-ons(i.e.. extended warranties, rustproofing)
Pay off your vehicle first.

Caldwell, of Edmunds, said. “Unless there has been a substantial change in your life circumstances – you’ve started a new construction business and now you need a truck; or you just had triplets and now you really need a mini-van – to have a new car loan and negative equity in your trade-in does not put you in a good place financially.”