One of the most difficult situations car owners encounter is owing more on a loan than their vehicle’s fair market value. You’ll hear this referred to by several different terms including “upside down” and “underwater.”
Either way, it boils down to the same thing — a problem. Fortunately, avoiding upside-down car loans is pretty easy if you adhere to the following guidelines.
Choose Your Car Carefully
One of the factors many people overlook when choosing a car is its potential resale value. Depreciation can really do a number on the value of a car. You can do everything else discussed here and still wind up underwater if you overlook this.
Most cars lose 20 percent of their worth in the first year. However, if yours is also one with minimal demand, or an issue causing it to fall out of favor in the marketplace, you’re going to find it loses even more value.
Let’s say you buy a full-size SUV and gas prices double eight months later. Demand will fall and so will the value of your automobile. If you need to sell it at that point, you’ll probably owe more than somebody is willing to pay for it.
Go With a 20 Percent Down Payment
As we mentioned above, the basic rule of thumb for depreciation is 20 percent within the first year. According to the experts at CarFax, you can also count on seeing the value decrease between 10 and 15 percent annually for the first four years after that. As a result, your loan will more closely track the value of the car with a 20 percent down payment as time goes on.
Don’t Finance Taxes and Fees
Keeping add-on costs separate will lower your loan amount — and, by extension, your ongoing balance. Which, by the way, is even more important if you’ve had credit problems. Even the best bad credit car loans will have higher interest rates. With this in mind, you should also shop for the lowest interest rate your credit score will permit. While we’re on the subject, pass on dealer-installed extras like window etching, upholstery protection and other items of that ilk. These are typically a waste of money and you can do them far more affordably on your own if you really must have them.
Avoid Long-Term Loans
The shorter the term of your loan, the more closely the value of your car is likely to match your loan balance. On the other hand, short loan terms do come with higher monthly payments. Your goal should be to balance what you can comfortably afford to pay each month against the length of the loan.
If this means buying a more reasonably priced car, then so be it. If you find yourself needing to finance the car of your dreams longer than 60 months, you’re might be setting yourself up for a nightmare.
Odds are you really can’t afford that car. Look at something else instead.
Additionally, most vehicles will have depreciated quite significantly by the 60th month. Extending a loan beyond that time frame will, in all probability, flip you upside down.
Pay Off Your Car Before Trading it in
Rolling an existing balance into the loan on a new car will submerge you right off the top. You’ll be paying off two vehicles simultaneously, even though you’ll only have one in your driveway.
Never allow yourself to be convinced this is a good way to get out of a loan because it isn’t. The outstanding amount won’t go away, it will continue to haunt you every month in the form of a higher-than-necessary car payment on your new car.
These are four of the most common strategies for avoiding upside-down car loans. Implementing these strategies will give you the best shot at paying off your loan balance before it exceeds the value of your car.