Smart Ways to Manage an Underwater Car Loan


What does it mean to have an underwater car loan and why is it a problem? Let’s take a look at a serious problem that can sneak up on unsuspecting car owners.

What Is an Underwater Loan?

A couple meets with a credit union representative to discuss smart ways to manage an underwater car loan.It sounds a little silly, but an underwater or upside-down car loan is no joke. It’s a trap that many car owners, particularly young people or those who have borrowed heavily to afford their vehicle, don’t see coming — no matter how good their windshield wipers are!

Being underwater on an auto loan means owing more to your lender than your car is worth. In other words, if you sold your car today, you would not receive enough money to pay off the remainder of your loan. You would still owe your lender.

Also known as having negative equity in your loan, it’s a risky situation that you want to avoid.

How Does It Happen?

There are several ways to go underwater on your car loan. Anything that negatively affects the resale value of your car, such as accident damage or ill-considered customization, can put you closer to going upside down.

However, the things that can really put you underwater often have to do with the value of your auto loan. These include:

  • Paying more for a car than it is worth
  • Taking out an auto loan with no down payment
  • Taking out a long-term loan on a relatively cheap vehicle
  • Rolling over the negative equity on an old car into a new loan

This is because being underwater on a loan is really about equity.

The Negative Equity Trap

Equity is the market value of your car, less the amount you have already paid on your loan. It is, in effect, the portion of the value of your car that belongs to you. Ideally, the equity you hold in your car should increase as you pay off the loan, meaning that when you sell the car, more of the money you get goes into your back pocket.

If you’ve put yourself on the back foot, equity-wise, usually by taking a nothing-down loan or stretching out your loan too much, it will take you longer to build up equity in your vehicle, which is itself losing value — fast.

If your loan is worth more than your vehicle, you have negative equity in your vehicle. This means you owe your lender for something that you do not have.

Why Is an Underwater Car Loan a Problem?

Being underwater on a loan is not a problem if you can continue making payments while still driving your car, but it’s a risky choice because if you unexpectedly lose or need to sell your car, you could owe your lender money you do not have.

How could this happen? Here are a few scenarios that could see negative equity coming back to bite you:

  • You total your car: After the accident, insurance pays the market value of the vehicle (if you’re lucky), but unless you have gap coverage, you’ll still owe the full value of the loan.
  • You can’t make payments: Your financial situation changes and you have to sell your car or downsize. You lose your current car and still have to pay the rest of your loan.
  • Your needs change: You need to commute further or transport a new baby. It is much harder to upgrade because you owe money above the trade-in value of your current car.

Either way, being underwater on an auto loan means your options are fewer and you could unexpectedly be on the hook for thousands of dollars.

What Can I Do About It?

Ok, deep breath. Let’s dive in and see what you can do about taking responsibility for your underwater car loan.

Take Stock

First, find out how deep you’re in. Check your loan balance with your lender or take a look at your most recent statement. Next, look up the value of your vehicle in a used car pricing guide like Kelley Blue Book, the National Auto Dealers Association, or Finally, subtract the loan balance from the value of the car. If the answer is less than zero, you could have a problem.

Take Action

Now is the time to take action. This isn’t easy, especially if you’re comfortable with your current set-up, but it’s the right thing to do. You have several options:

  • Refinance: Talk to lenders about refinancing your car. While you will still owe the same amount, if you make a down payment or increase your monthly payments, you will begin to reduce your equity deficit and save money on interest.
  • Pay down your loan: Make extra payments on your auto loan. The faster you can do this, the faster you’ll get above the equity waterline. Be sure, however, that your lender applies extra payments to your principal and not the loan interest.
  • Mind the gap: Keep making your payments and consider taking out gap insurance that will cover the difference between an insurance settlement and your outstanding loan amount. And keep driving — carefully!
  • Sell your car privately: If your negative equity is relatively small, you might be able to negotiate to sell it in a private deal for more than the quoted trade-in value. Just be sure to do your research. 
  • Take a lease: Talk to your dealer about trading your car in for a leased vehicle. Your lease payments will include the negative equity. At the end of the lease, you will walk away with no vehicle — but you will not owe anything either.

Let Us Help With Your Underwater Car Loan

Realizing you’re underwater on your auto loan is no fun. It takes foresight and commitment to recognize threats to your financial future — and to do something about them.

At Members Heritage Credit Union, we are well placed to help our members negotiate life’s financial challenges. We know how important owning a vehicle is, and we offer specific benefits designed to make refinancing a car easier. These include:

  • No application of processing fees
  • 100% financing
  • No prepayment penalties
  • Skip-A-Payment option

Click below to learn more about how to go about refinancing a vehicle.

How to Refinance an Auto Loan

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