How to Refinance an Upside down Car Loan

Have you ever been tempted by a new and exciting car that has just hit the showroom? Some people fall so much in love with the latest releases that they will seriously consider trading in their current ride in order to get their hands on one. And best of all, the newer the car to be traded in is, the higher that trade allowance will be. It sounds simple, doesn’t it?

Well, in the case of most of us, there’s a little problem. Assuming we were unable to pay cash for our current vehicle, we financed it. Moreover, if that car is less than five years old, money is likely still owed on it, so at the same time, this means that the newer our current car is, the higher the payoff balance will be as well. And there’s more discouraging news to come.

Because today’s car prices have reached the stratosphere, those new car loan terms of two or three years that our grandparents enjoyed have all but become a thing of the past. In fact, it is not uncommon to see liens that stretch out to seven years. Lenders of course make their money by charging interest on loans, and therein lies the problem, for the payments in an early part of a loan consist mostly of these finance charges. As a result, the principal amount owed on the vehicle will amount to very little in the beginning and only slowly increases as those monthly obligations are met.

The worst part of the problem; however, isn’t the fact that very little principal has been paid. Instead, it is rather the depreciation. This can be thought of as the hit the car takes in value as soon as it’s driven off that dealership’s lot. So in the end, the dilemma most people face when they consider trading in that late-model car is that they will be “upside down” on their loan. In simplest terms, this means that the person owes more on the car than what a dealership will allow for a trade allowance. This is also referred to as negative equity.

Despite potential new car buyers finding themselves in this situation, it is still possible to refinance such a loan. In fact, many shoppers; especially those who simply must have that latest beautiful, new, and improved model seen in the magazines, on TV commercials, a website, or  a dealership’s showroom do this frequently. The following example illustrates how this is accomplished:

Let’s assume that brand new, just-released model has a price of $30,000. You drive a two-year-old car that is worth $15,000 in trade value, but the payout is $17,000. This will bring that shiny new car’s price down to $15,000, but the $17,000 still owed is tacked onto the $15,000 price. Thus, the new car will require $32,000 to exchange hands. Therefore, when you owe more on a trade than what it’s worth, the amount of that difference is added back onto the final sales price of the replacement vehicle. This takes care of your previous obligation, but at the same time, it increases your new obligation.

It should also be noted your trade-in will reduce any applicable sales taxes whether you are upside-down or not. Thus, if the amount you save in sales tax is greater than the difference between trade-in allowance and payout, you can actually come out ahead!

One thing that must be kept in mind is that this type of financing will only fly if the replacement vehicle is higher-priced than the value of your current one. It wouldn’t make sense for a dealership to either take a loss on the vehicle they have for sale or attempt to jack the retail price up to a ridiculously high amount. Moreover, it would likewise make no sense to try to finance a vehicle for an amount thousands of dollars over its true value! About 99% of lenders will concur with this sentiment.

To reiterate, refinancing an upside-down loan amount is far from impossible, but it is prudent that the potential customer realizes that any remaining balance on his or her trade-in vehicle must and will be paid. These are the three key things to remember:

A) The higher that replacement vehicle is marked up for profit, the more negotiating room there will be to cover the negative equity one has in a trade-in.

B) The lower the price of the replacement, the opposite will occur and there will be hence less bargaining room.

C) If the price of the replacement car is lower than your current trade-in value, such as in an even older used car, such refinancing won’t work.

Car payments aren’t cheap. In most instances they will rank second only to home mortgages or monthly rent. Therefore, to avoid finding yourself in this situation of paying off an upside-down loan on a car you no longer want a year or two down the road, make sure that the car you buy is exactly what you want in the first place! If you can’t help but fall in love with every new model that comes out, do yourself a favor: At the very least, bide your time until your current loan is right-side up! Patience? It’s a virtue.