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What is an upside-down car loan and how do I get out of it?

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An upside-down car loan happens when you owe more than the vehicle is actually worth. To avoid being upside-down on your loan, or at least minimize the time that you are in this precarious financial state, you may have to make extra payments or adjust your insurance coverage.

What is an upside-down car loan?

A car loan becomes upside-down when you owe more on the loan than the vehicle is worth. For example, your loan would be upside-down if your car’s value is $12,000 but your loan balance is $15,000. In this scenario, you have negative equity of $3,000.

Being upside-down on a car loan isn’t always an issue. If you don’t plan on selling your car, you can continue to make payments on your loan until it’s paid off. It won’t change how you interact with your lender

But it can make some situations more difficult. If you want to trade in your vehicle, you’ll need to pay that negative equity. The same is true if your car is totaled. Additionally, having negative equity can make it harder to get a future auto loan with reasonable rates. You can technically roll any negative equity into a new loan, but this increases your chances of being upside-down again.

How you end up with an upside-down loan

There are two common ways people become upside-down on their auto loans:

  • Financing a car with no money down. Vehicles can lose as much as 20 percent of their value in the first year of ownership. It won’t take long for your vehicle’s depreciation to overtake your equity if you don’t make a down payment or borrow too much money.  
  • Picking a long repayment term. Some lenders offer new car financing for up to 84 months (or seven years). This keeps monthly payments low, but your car will likely depreciate beyond your original purchase point by the end of that period.  

It’s also easy to get upside down if your car loses value quickly — luxury models are prone to it.

And in the early years of the loan, a bigger chunk of your payment goes toward interest rather than toward principal. Similarly, the higher your interest rate, the more interest you’ll pay the lender and the less that goes toward paying down the principal. Both increase your chance of owing more than the vehicle is worth.

How to find out if your car loan is upside-down

Even though having an upside-down car loan isn’t always bad, it is useful to know where your loan stands. Determine if you have negative equity by following three quick steps: 

  • Request a payoff quote from your lender. A payoff quote is a document that shows exactly how much you currently owe on your vehicle, including interest charges. 
  • Calculate how much your car is worth. Kelley Blue Book’s car value calculator gives you a low estimate of what your vehicle might be worth if you decide to trade it in. A private-party sale value, however, may net a higher price for the car. You can also request trade-in quotes from dealers in your area to gauge possible sale price. 
  • Do the math. Subtract the remaining loan balance from your car’s value to determine your equity. If the number is negative, you are upside-down on your car loan.  

How to get out of an upside-down loan

It’s easier to sell or trade in your vehicle if your loan is not upside down. You have a few options if you’re already upside down.  

  • Make extra payments. Making an extra payment each month will help you build equity faster, especially if you tell your lender to put the payments toward the loan’s principal. 
  • Get gap insurance. Gap insurance covers what your insurance company pays for the vehicle and what you owe on the loan, which helps reduce your bill if your car is totaled.  
  • Refinance. Refinancing your loan into a shorter term or lower interest rate will ensure that more of your payments go toward your principal, which will help you catch up on your equity quicker.  
  • Pay it off. If you are planning to keep your vehicle, continue to make payments until the loan is paid off. Whatever remaining equity the car has at the end of your loan can be turned into cash via a sale or trade-in. 

4 tips to avoid going upside down on a car loan in the future

If you’re not upside down but are planning on buying another car, there are some solid ways to lower your risk of going upside down. The biggest factor? Pay as much as you can upfront. 

  1. Make a down payment. A down payment — ideally 20 percent of the total car cost — can prevent owing more than the car is worth. Take advantage of cash-back manufacturer rebates and trade-in value from your previous car.  
  2. Pay the taxes and fees outright. Rolling taxes and fees into your loan automatically puts you upside-down, since you’re financing more than the car is worth. Instead, cover any additional costs with your down payment. 
  3. Choose an appropriate loan term. If you can afford it, choose a loan term equal to the amount of time you’re expecting to keep the car. This reduces the total cost and helps you avoid making payments as your vehicle loses value.  
  4. Choose a vehicle with slow depreciation. Some cars hold their value better than others. Sources like Kelley Blue Book and Edmunds calculate expected depreciation to help your research.  

The bottom line

Being upside down simply means you owe more than your car is worth. There are ways to avoid it and ways to get out of it. And it’s pretty much inevitable, especially in the beginning of your loan term.  

However, there are ways to minimize the time you spend upside down. Making extra payments, increasing your down payment amount and refinancing are all viable ways to avoid staying upside-down and start building equity. When you’re shopping, use an amortization table to estimate how soon you’ll cross from negative to positive equity. 

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Written by
Rebecca Betterton
Auto Loans Reporter
Rebecca Betterton is the auto loans reporter for Bankrate. She specializes in assisting readers in navigating the ins and outs of securely borrowing money to purchase a car.
Edited by
Auto loans editor