Underwater Auto Loans: What to Do

Being "upside down" on your car loan is stressful, but you have options. Here's how to handle it.

What Does "Underwater" Mean?

You're underwater (also called "upside down" or having "negative equity") when you owe more on your car loan than the car is worth.

Example:

• Your car's value: $18,000
• Your loan balance: $22,000
• You're underwater by: $4,000

This happens to millions of Americans. According to industry data, about 25% of trade-ins involve negative equity.

How Did This Happen?

Several factors cause negative equity:

1. Rapid Depreciation

New cars lose 20-30% of their value in the first year. If you made a small down payment, depreciation outpaces your payments.

2. Long Loan Terms

72 and 84-month loans keep you in debt longer. Your car loses value faster than you pay down the loan.

3. Rolling Over Negative Equity

If you traded in a car where you owed more than it was worth, that debt got added to your new loan.

4. Low or No Down Payment

Without a down payment cushion, you start the loan already close to being underwater.

5. High Interest Rates

More of your payment goes to interest, less to principal. You pay down the balance slowly.

Why Being Underwater Matters

Negative equity becomes a problem if you:

Need to sell the car: You'll need to pay the difference between sale price and loan balance out of pocket.

Want to trade in: Dealers will roll the negative equity into your new loan, making the problem worse.

Total the car in an accident: Insurance pays the car's value, not your loan balance. You'll owe the difference.

Have financial hardship: You can't simply walk away from the loan.

Your Options When Underwater

Option 1: Keep Driving and Pay It Down

Best for: People who like their car and can afford payments

This is often the best choice. Every payment brings you closer to positive equity.

How to accelerate:

• Make extra principal payments when possible
• Round up your payment ($487 to $500)
• Make bi-weekly payments (26 half-payments = 13 full payments per year)

Timeline to positive equity:

Option 2: Refinance to a Lower Rate

Best for: People with improved credit or high-rate loans

A lower interest rate means more of your payment goes to principal. You'll build equity faster.

Requirements:

• Many lenders refinance up to 125% loan-to-value
• Need decent credit (usually 600+)
• Car typically under 100,000 miles and under 10 years old

Warning: Don't extend the term. A longer loan keeps you underwater longer.

Option 3: Sell Privately and Pay the Difference

Best for: People who need out of the loan and can cover the gap

Private party sales bring 10-20% more than trade-ins. You might still be underwater, but less so.

How it works:

1. List car for private party value ($18,000)
2. Find a buyer
3. Pay off loan ($22,000) by combining sale price + $4,000 from savings
4. Transfer title once loan is paid

If you can't cover the gap: Some lenders offer personal loans to bridge the difference.

Option 4: Trade In and Minimize the Damage

Best for: People who must get a different car now

If you need a different car, minimize negative equity impact:

Do:

• Choose a reliable used car with low depreciation
• Make a large down payment on the new car
• Choose the shortest term you can afford
• Research vehicles that hold value well

Don't:

• Buy another new car (more depreciation)
• Extend to 72 or 84 months
• Add more negative equity to the pile

Option 5: Voluntary Surrender (Last Resort)

Best for: Severe financial hardship with no other options

You can return the car to the lender. But this isn't a clean break:

• Your credit takes a major hit (similar to repossession)
• You may still owe the "deficiency balance" (loan minus auction price)
• This stays on your credit report for 7 years

Only consider this if you truly cannot afford payments and have no other option.

What NOT to Do

Don't Stop Making Payments

Repossession destroys your credit and you'll still owe money.

Don't Ignore the Problem

Negative equity grows if you do nothing. Create a plan.

Don't Trade In for a More Expensive Car

This makes the problem worse. You'll end up even more underwater.

Don't Get Voluntary Repo Unless Desperate

The credit damage is severe and you'll likely still owe money.

Preventing Negative Equity in the Future

Learn from this experience:

Make a larger down payment: 20% down on new cars, 10% on used cars.

Choose shorter loan terms: 48-60 months maximum.

Buy used: Let someone else take the first-year depreciation hit.

Buy vehicles that hold value: Trucks, SUVs, and certain brands (Toyota, Honda) depreciate slower.

Avoid rolling over negative equity: Pay off your current loan before buying.

Consider GAP insurance: Covers the difference if your car is totaled while underwater.

GAP Insurance: Protection Against Being Underwater

GAP (Guaranteed Asset Protection) insurance covers the difference between your car's value and loan balance if the car is totaled or stolen.

Example:

• Car totaled in accident
• Insurance pays: $18,000 (car's value)
• You owe: $22,000
• Without GAP: You pay $4,000 out of pocket
• With GAP: Insurance covers the $4,000 difference

Cost: $20-40/year through your auto insurer, or $300-700 one-time through dealer

Get GAP if:

• You put less than 20% down
• You have a loan term over 48 months
• You're financing a car that depreciates quickly

Skip GAP if:

• You put 20%+ down
• You could cover the gap from savings
• Your car holds value well

How to Check If You're Underwater

Step 1: Find your loan balance Check your lender's website or call for your payoff amount.

Step 2: Find your car's value Get values from:

• Kelley Blue Book (kbb.com)
• Edmunds (edmunds.com)
• NADA Guides (nadaguides.com)

Use "private party" value for the most realistic number.

Step 3: Calculate Car value minus loan balance = your equity position

Negative number = you're underwater

The Bottom Line

Being underwater on your car loan isn't ideal, but it's manageable. In most cases, the best strategy is:

1. Keep the car and make payments
2. Add extra to principal when possible
3. Consider refinancing if you can get a lower rate
4. Don't trade in unless absolutely necessary

Time is on your side. Every month, your balance drops and your car's depreciation slows. Stay the course, and you'll reach positive equity.

Last updated: January 2025