What to Do if Your Car Loan is More Than Your Car is Worth

What to Do if Your Car Loan is More Than Your Car is Worth

Written by Bryan Daly
Fact-checked by Caitlin Wood
Last Updated December 9, 2021

In our society, cars are a basic necessity, one that the vast majority of people want at their disposal so they can from point-A to point-B with relative ease. While walking, biking, and public transit may be an option, most drivers would rather the added convenience that comes with having access to their car, truck, or other motor vehicles. After all, sometimes a nice toasty car in the winter is preferable to waiting outside for the bus, especially when you’re late for work or need to get somewhere quickly. The only problem is that cars are expensive. No matter what year, make, or model your car is, or how much mileage it has on the odometer, someway, somehow, you’ll need to sink some of your hard earned money into it to keep it on the road.

Check out the cheapest electric cars in Canada.

Unfortunately, car costs also range far beyond the initial price tag. At first, you might think that attractive financing rates and stellar reviews are enough to justify the purchase of a vehicle, especially a brand new one. However, buying a car of any kind is a huge financial responsibility, one that should not be taken lightly. That’s how a lot of drivers end up with negative equity in their car following their car loan, which is commonly known as being “upside down”. The temptation of owning a vehicle at all often outweighs their hesitation, so they sign on for an auto loan they can’t realistically afford. Then, shortly after, they end up under a large amount of debt and find themselves lacking the necessary finances to pay it off. That being said, if you’re a driver and your car loan is costing you more than your car is worth, or you feel that it might be soon, stick with us, we’ll be discussing everything you need to know below.

Want to know how much car you can realistically afford? Find out here.

Auto Financing 101
Check out our Auto Financing 101 infographic, click here

What Does Being “Upside Down” On Your Car Loan Mean?

One of the most important things to realize when it comes to the financial aspect of owning a car is just how quickly their value diminishes, especially for new vehicles. In fact, most cars lose an estimated 11% of their total value the minute they leave the dealership, and around 25% by the end of the first year they’ve been driven. Then, once the car has lost a large portion of its value, it’s extremely difficult to get any of that value back or get anywhere near what you paid for it, if and when you sell it. As we said, this is particularly true when it comes to brand new cars. Most people cannot afford to buy a new car all in one go. They need to secure a car loan and pay it off slowly throughout the years. That’s where the financial problems often start.

For more information about vehicle depreciation and negative equity, visit the Government of Canada website.

Essentially, being “upside down” on a car loan means that you, the driver, have started to pay more towards the car than it’s actually worth, landing you in the zone of negative equity. Equity refers to how much money you’ve invested in the car, similar to the kind you gain when mortgaging a house, only you can’t always use it to buy other things, like you could a HELOC (home equity line of credit). In order to use it, you would have to own the car completely and use it as an asset for collateral, which isn’t an option when you’re in the middle of paying a car loan.

When financing a new or lightly used car, drivers generally have two options. They can get a car loan through the dealership or through their alternate lender, which for most means their bank, credit union or other financial institution. A driver can “buy” a car, then pay it back over a certain period of time with weekly, bi-weekly or monthly payments, which include interest. However, until the full sum of the loan is paid, the lender will retain the rights to the vehicle itself. So, if the driver fails to keep up with their payments, their lender (or dealership) has the option of repossessing the car. So, to avoid such an event, car loan lenders will usually allow drivers to reduce their payments or lengthen their payment schedule, both of which will ultimately stretch out their overall amortization period. These stretched out payments, coupled with other car-related costs, such as fuel, and the rapid depreciation of the vehicle can cause the driver to spend more on the car than it’s valued, making them upside down on their loan.

Other Elements That Cause Negative Vehicle Equity

The payments aren’t the only elements that cause drivers to become upside down on their loans. When purchasing a vehicle from a dealership, drivers also have the option of making a down payment in order to pay for it quicker. However, if they choose not to or don’t make one that’s large enough, their payment period could once again be extended, landing them with negative equity somewhere down the line. While 20% is usually the suggested down payment, it should be, at the very least, large enough to cover the cost of the vehicle’s immediate depreciation. Let’s say the car costs $30,000 but lost the full 11% of its value after you left the lot. So, your down payment should be at least $3,300, more if possible to reduce your payment period.   

Negative equity can also happen if your interest rate is too high. If your credit score was unfavorable or your financial situation too risky to qualify for a more reasonable rate, the interest that’s tacked onto your regular payments can also cause financial strain. Whether you have bad credit or not, it’s often a good idea to get pre-approved for your car loan through your financial institution. Doing this will not only let your lender know that you’re serious about buying a car but will also give you a better idea of the interest rate you’ll be getting. If your rate ends up being so high that you think you’ll have trouble managing it, you might want to wait until you can improve your credit and lower it.

The car itself might also be the issue. Another appealing aspect of vehicle financing is that it can allow the driver to buy a car they wouldn’t have been able to afford initially. If you want a luxury model, you’ll have to pay a luxury price. The payments seem reasonable at first, especially when they’re reduced to only a few hundred dollars a month and you’re making a decent income. Then a few years later, you’re still paying for a Mercedes you can’t really afford. Who knows? You could experience a sudden loss of employment or another financial emergency. So, while the allure of a fancy vehicle might be strong, it’s best not to give in unless you’re absolutely sure you can afford it. If not, consider buying something more reasonably priced, even if it isn’t as visually appealing as you’d like. You can also try financing a used vehicle until you can afford something higher end.

Check out this infographic for more information on financing new and used vehicles. 

How to Get Out From Under Your Upside Down Car Loan

If you’re reading this article, we’ll assume that you’re already upside down on your car loan or are in danger of it getting that way. If that’s the case, there are a few things you can do to at least minimize your debt and get out from under it faster than you would by leaving it to chance. For the sake of argument, we’ll also sway you away from either lengthening your payment period or reducing your monthly payments. While both options might help you out in the immediate future, they’re also two ways of stretching out your debt for longer, meaning you’ll end up paying more down the line. So, here are a few more conventional solutions that almost any driver can start with.  

Save More, Spend Less

Pretty basic, probably not a total game-changer, but a good way of at least improving your finances in general so you have an easier time affording your payments. Save as much and spend as little money as possible. Buy discount consumer goods, sell anything you don’t need, even get a second job or ask for a pay increase if you have to, then store the extra money in your savings account. Afterward, use your savings to pay down your debt aggressively. You can even increase your payments, therefore shortening your overall payment period.

Learn how to better budget for your car.

Reduce Your Vehicle Costs

When you’ve got a new car in your driveway, you’ll, of course, want to drive it. However, the more your drive, the more you’ll spend on gas. Even electric cars can cost a couple of dollars an hour to charge with a curbside port, depending on what city you live in. Just the same, the more wear n’ tear your car accumulates, the faster its value will depreciate. While dealership cars, new or used, usually come with some kind of warranty where certain car issues, such as basic maintenance and factory faults will be covered by the dealership itself, accidents or any incidents you are the cause of won’t be. You can also reduce car costs by taking public transit (or any other form of transportation) or carpooling when possible. If you are planning to drive everywhere, try to buy a car that has good gas mileage and a reputation for being reliable.  

Find out how dealerships take advantage of Canadians.

Consider Trading Down

While it might pain you to do so, trading your vehicle in for something more reasonably priced could save you a lot of stress down the road. You can bring your vehicle back to the dealership, trade it in for an older model or something more used. True, you will likely be taking a significant loss from what you initially paid, and you may also be upside down with this new car loan. However, your monthly payments and insurance rate will probably be much lower, making your payment period shorter and reducing your debt load greatly. The problem here is that not all dealerships offer trade-ins as an option, so discuss this at your chosen dealership before you buy the car.

Read this to learn more about trading in a vehicle that isn’t paid off.

Consider Selling

Once again, this is often an inconvenient, disheartening solution that most people only use as a last resort. However sad it might make you, considering you’ll likely have sunk a lot of money and effort into your car already, selling your car might be the only way to get out from under your loan debt. While selling might not seem like a good idea at first, it’s better than ending up in debt for years and years to come. You’re already paying more than the car is worth, so it’s best not to drain away all your savings in the process. Advertise your car on any used items website, like Craigslist or Kijiji. Since you technically don’t own the car until your loan is paid, you’ll need to contact your lender and request a transfer once you’ve found an interested buyer. The issue here is that, when it comes to most lenders, the full sum of the loan needs to be paid before the car’s title can be switched to a different name. This can be done using either the seller’s or the buyer’s money. If the buyer is paying right away, they can make two payments, one towards you for the car and one towards the lender for the rest of the loan. Once again, you likely aren’t going to get back what you already invested in the car, but you will get out of debt quicker.

Learn how to voluntarily surrender your car.

Open a Line of Credit

This isn’t always advisable, simply because if not managed properly, a line of credit can put you in even worse debt than you were before. That being said, when it’s down to the wire, opening a regular line of credit or a HELOC can help you pay off your car loan faster. If you’re in good financial standing, meaning you have favorable credit, a stable source of income and or enough home equity, your financial institution should grant you an appropriate amount. Just make sure that the payments you’re making towards your line of credit are more manageable than those of your car loan, that you’re making them on time and meeting at least the minimum monthly payment to avoid defaulting.

Paying More Than The Price Tag

When it comes down to it, you will pretty much always end up paying more than a car itself is worth, especially if the car is new or only gently used (think a lease turn in) from a dealership. This is mostly due to the interest payments associated with all forms of financing. Dealerships and other lenders need to charge interest for their products, otherwise, they wouldn’t be making a profit. When buying a dealership car, you’re not only paying the initial price tag, you’re paying interest on top of it. Therefore, no matter what shape the car is in or how quickly you manage to pay it off, you’re still paying more than the car is worth. The key, however, is to determine just how much more you’ll end up paying and trying to reduce that price as much as possible before you sign any contracts.

For more ways of avoiding car loan debt, click here.  

This isn’t to say that financing a vehicle is always a bad idea, far from it. As we mentioned, buying any vehicle all at once, let alone a new one, is not within the realm of possibility for the majority of drivers. It’s inevitable that, if you’re not buying your car from a private seller, you’re going to have to ante up for it. However, vehicle financing does come with benefits. For example, a record of timely, full car payments is a good way of raising your credit score. Just remember, it is necessary if you are going the financing route, to really consider every other area that you’ll be spending money. Chances are, once you’ve bought the vehicle, it’s not going to stay in your garage covered in a plastic sheet forever. At some point, you’ll want to drive it and breathe in that new-car smell.    

Rating of 4/5 based on 11 votes.

Bryan is a graduate of Dawson College and Concordia University. He has been writing for Loans Canada for five years, covering all things related to personal finance, and aims to pursue the craft of professional writing for many years to come. In his spare time, he maintains a passion for editing, writing screenplays, staying fit, and travelling the world in search of the coolest sights our planet has to offer.

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