An upside-down, or negative equity, car loan is when your loan balance is worth more than the value of your car. So if you owe $11,000 on your car loan, but the market value of your car is $9,500, than the loan would be upside down by $1,500. You could also say that you have $1,500 worth of negative equity.
Having an upside-down car loan can be risky, especially since standard insurance policies only cover up to the value of your car. But there are a few ways to turn around negative equity — or get out of an upside-down car loan altogether.
A car loan can go upside down in several situations. Financing a new car over a long term is one common way — especially if that term is longer than 60 months. Having a high interest rate, foregoing a down payment or buying a car that’s out of your budget can also lead to an upside-down car loan. And rolling over a previous loan during a trade-in also puts your loan at risk of becoming upside down.
One of the simplest ways to get out of an upside-down car loan is to make extra repayments. This reduces your balance until car loan is right-side-up again and gets you out of debt faster.
Before you get started, calculate your negative equity — the difference between your loan balance and how much your car is worth. Negative equity gives you an idea of how much you need to repay to flip your loan right-side up and how long it’ll take.
Some lenders charge a penalty when you repay your loan early. Not only does this mean you won’t be able to save on interest, but it’ll also cost you more to get above water. Reach out to your lender to find out its prepayment policy before you start making extra payments.
Refinancing your car loan involves trading in your loan for different loan, ideally with more favorable rates and terms. Refinancing for a shorter term could also be a good way to pay off your loan early if your lender charges prepayment penalties. Refinancing at a lower interest rate can help you get out of an upside-down car loan by lowering the total amount you’ll pay towards your car loan overall.
Generally, you need to have good to excellent credit and a low debt-to-income (DTI) ratio to get the best deal on refinancing. Refinancing also might not be the best choice if you have a large amount of negative equity, since some lenders have maximum loan-to-value (LTV) ratios for refinancing applicants.
When extra repayments and refinancing aren’t an option, you can sell your car to a private party and use the profits to pay off most of your loan. You’ll still be responsible for the rest of the balance — and be out of a car. But it could prevent you from defaulting on a negative equity car loan and taking a hit to your credit score.
You can figure out how much your car is worth by getting it appraised by a mechanic. You can also get a ballpark idea from websites like Canadian Black Book, Auto Trader Canada, and Kijiji Autos
Consider making repairs or having your car detailed so you can up the price — or at the very least give it a good wash. The more you’re able to sell it for, the more you’ll you can put towards your upside-down car loan.
If you’d rather not sell your car, you can also trade it in at a dealership for a less pricy used vehicle. Try to go for a car with a value that’s close to your loan balance.
But watch out for dealership financing: It’ll often roll what’s left of your old loan into the new one, which could land you with another upside-down car loan.
If none of these options seem viable, consider signing up for a session with a credit counseling agency. These nonprofit organizations can help you figure out your best plan of action and come up with strategies to better manage your personal finances.
The Canadian Government has a list of government-approved credit counseling agencies on its website.
Here are a few strategies to help you avoid negative equity on your next car loan:
There’s more than one way out if your car loan is worth more than the value of your vehicle, especially if you have good credit. Not sure which is right for you? Consider calculating your negative equity and going from there. For more information on how car loans work, check out our guide to auto financing.
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