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How to Avoid Being Underwater on a Car Loan

A growing number of people are underwater on their car loans. Simply put, that means their outstanding balance is worth more than the car. Roughly 32% of people in 2016 were underwater on their car loans in 2016, compared to approximately 23% just five years previously. Many of them were Millennials.

Being underwater can exert a serious hit on your finances. You are paying every month to have negative equity. (Negative equity is another term for owing more than an asset is worth.)

There are many reasons for the rise in underwater car loans. A chief one is lower down payments on car loans. Cars depreciate 15% to 20% every year. If you pay $20,000 for a car with no down or little down payment, you could still owe $15,000 in three years. The car, by contrast, has lost from 45% to 60% of its value. It’s only worth $9,000 to $12,000. Negative equity, to the tune of $3,000+.

The price of cars is steadily rising, as well.

The important money-saving question is, how do you avoid being underwater on your car loan? Here are seven ways.

  1. Keep driving your car.

    Negative equity only really matters if you come to sell or replace the car. Then, whoops, you can’t make a profit because you still owe more than you can sell or replace it for. As long as your payments are budgeted and your car is working, simply drive the car until the loan is fully paid.

  2. Research what cars are worth.

    Few things beat research as a way to save yourself from bad financial moves. Choose an unbiased source like Consumer Reports to find out price ranges, average repair records, and more. Don’t be stampeded into believing you must spend $18,000 or above once you’re on the lot. Know what the ranges are for the kind of car you’re interested in.

  3. Consider a used car.

    If depreciation is your enemy in car value, it can also be your friend in saving money if you buy a preowned car. New cars lose 15% to 20% of their value pretty quickly. That means you can buy a year-old car for 20% less than the owner paid for it 12 short months ago. If you’re willing to get a five-year-old vehicle, the savings can be substantial. Well maintained older cars can be very good buys for your buck.

  4. Save up for a large down payment.

    The more you can put down on your car, the less of a loan you will have to take out. If you pay 20% down on a $20,000 car, you only have $16,000 in a loan.

  5. Shop around to get the lowest interest rate.

    Car payments are determined by amount of loan, yes, but interest rates also play a role. The lower the interest rate, the lower your monthly payment. Your loan payments will be more affordable, which means you can pay down the principal more quickly if you want. Generally, credit unions can offer the most reasonable rates. Dealers are often the most expensive.

  6. Avoid frills.

    Knowing what you want is key. Once you hit the dealer’s lot, you may be talked into expensive tires, a sun roof, and more. All of those drive the price of the car up. The more car you buy, the more you pay for with the loan. All frills depreciate. Do you really want to be paying for a sun roof you use 5 times a month 10 years down the road?

  7. Pay down debt quickly.

    Be sure you get a car loan with no prepayment penalty. These allow you to pay down your loan quickly. If you double the amount of your payment, you’ll pay it off twice as quickly at least. Your loan will be discharged before you become underwater.