Upside-Down Car Loans

Don't monkeys hang upside-down sometimes? I know people do – at least financially. In fact, if you've bought a new car recently, there's a good chance you're upside-down right now.

With a car loan, upside-down means that your owe more on the car than it's worth. This is likely if you took out a loan with a small down payment or a long payback period.

Example:

New Car Cost: $25,000.00

Down Payment: $2,000.00

Annual Interest Rate: 7.50%

Loan Term: 60 months

At the end of one year your car would likely have a wholesale value of around $18,093. But your loan would have a balance of $19,062 You would be 'upside-down' to the tune of $968.

If you decided to trade in this car you would have to deliver the car to the dealer AND also give the dealer $968! Now the dealer isn't crazy, he's going to hide this. He will do his best to convince you that you are coming out ahead. But I guarantee he will get his $968. Always remember the dealer can prove anything with numbers.

So are you stuck with the car forever? Well actually no. In this example you break even just about at the end of the second year. So at the end of the second year you should be able to trade it in and receive at least some credit towards a new car.

The obvious point here is that you should wait until the car is worth more than the loan balance before trading in.

However, a more important point I'm making is that small down payments or long loan terms are asking for trouble. In the case of car loans, let some other monkey be upside-down. Make a large down payment and keep the term short.

You can work through this example and others here