When you have an upside down car loan (which can also sometimes be referred to as being “underwater”), it simply means that you currently owe your finance lender more than your car is currently worth. Upside down car loans can be a downside of buying any fast depreciating model or any new car really as at any point during your finance contract, your vehicle can easily fall into the category of being worth less the sum of the rest of your car payments.
Before we talk about the times that it can be very dangerous to be upside down on your car loan, why don’t we talk about some simple ways to avoid ever being in this position in the first place. Now, the easiest way to avoid this predicament is to actually buy a car you can really afford as a whole and not just in really attractive itsy-bitsy pieces also known as “easy monthly payments.”
You see, by stretching out that car loan on an expensive luxury model to anything over 5 years of finance payments you start running a tremendous risk of becoming upside down on your car loan. After that five year period you need to realize how much residuals plummet after that point and that there is an elevated likelihood of more expensive repairs as the car ages. Do you still want to be paying $800 a month on a 9 year old car no matter if it is a BMW or a Hyundai?
Even things like the average cost of insuring your vehicle, replacement of wear items like brakes and tires as well as your vehicle’s projected depreciation rate over 3 or 5 years (depending on the length of your loan or lease) is always a very important figure to look into before getting your heart set on a clunker that will be worth next to nothing in a few years.
Now, being upside down on your car loan isn’t necessarily something you would notice so long as the vehicle is running and hasn’t recently had any accidents or been totaled. The reason that being upside down on a car loan will cause you problems is that your insurance company will only reimburse you for the fair market value of your vehicle at the time of the accident. This figure is determined by your carrier and usually just mirrors the brutality of depreciation you see in the used car market. But you can always contest their findings.
Another way that this can creep into your life when you least expect it is when you have financial problems and decide to trade in, for example, the big gas guzzler for something you think will be far less expensive. Well, if you still owe a substantial amount on your old SUV, every penny of the original MSRP and financing that you still owe on that SUV or pick-up truck will be saddled to the back of that poor economical hatchback’s finance agreement. That much of a burden might just turn even a frugal Toyota Prius or Honda Fit economy model into another money pit.
Sometimes, however, you really have no choice when it comes to changing what kind of car you drive. People hit hard economic times, sometimes their families grow and other times a car just becomes mechanically unreliable. So do your homework before you buy a car and really consider whether or not you think this is the vehicle that you will definitely want in ten years. It’s Murphy’s Law of automotive ownership that its always the last car you think that you will own for ten years that you wind up owning for that long.
And it’s usually because you are underwater on your car loan for so long that you can’t afford to get rid of the aforementioned automotive albatross around your neck so be smarter than that and think ahead. Honestly, there is no bigger mistake when buying a new or used car than paying exorbitant interest rates or even worse—still paying off the interest from your last car loan on your current one. Just do a little research on your next car and work out a reasonable budget and your car loan should never end up upside down. Unless of course, you choose to go on an amusement park ride then you will more often than not end up physically but at least not financially upside down.