You want to sell or trade-in your car, but you owe more on the loan than the car is worth. This scenario happens to many people who finance the purchase of a vehicle, and it’s becoming more and more common. According to Edmunds’ Q3 2016 Used Vehicle Market Report, 25 percent of all trade-ins toward a used car purchase have negative equity, with an average negative equity at the time of trade-in of $3,635 – a new record for the used car market.

Are you upside down?

To find out whether your car loan is upside down, look up the value of your vehicle using Carvana’s Cardian Angel vehicle valuation tool. If the value is less than the balance on your current loan, you are upside down by the difference.

Car loans may be upside down for a variety of reasons.

  • Low down payment: Dealerships often offer incentives for new cars, including low or no down payment loans. New cars lose about 20 percent of their value in the first year, so a small down payment can cause the balance of your loan to soar above its actual value.
  • High interest rate: The higher the interest rate on your loan, the less you’re paying toward the loan’s principal each month and the more likely you are to become upside down, even if you made a decent down payment.
  • Longer loan term: Extended loan terms keep your monthly payment low, but they’re also more likely to be upside down.

Being upside down on your car loan may not pose a problem, as long as you can hold onto the car until you have some equity. But if circumstances cause you to need to sell the car, you may need to come up with cash to pay off the difference.

How to handle an upside-down car loan

If you find yourself upside down on your loan, the best course of action is continue paying down the debt, perhaps even making extra payments, until you have some equity in the car. If that isn’t an option, consider these ideas.

Pay off the car with a home equity loan or line of credit

Using a home equity loan or line of credit (HELOC) to pay off your car loan may be a viable option if you’re having trouble making your monthly car payment due to a temporary financial setback. Often, you can lengthen the repayment period, thereby reducing your monthly payment.

But before you take that route, consider that HELOCs are often variable interest rate loans. If interest rates rise, your monthly payment may go up. Also, even if qualify for a lower interest rate with the HELOC than you’re currently paying on the car loan, you may end up paying more in interest by stretching out the loan term. In some cases, the HELOC could end up outliving your car.

Pay off the car with a personal loan

Paying off the car with a personal loan could be a smart idea if you don’t plan on buying another car. In that case, you would apply the proceeds from the sale to the balance of the car loan, then take out a personal loan to cover the remaining balance. However, because personal loans are unsecured, they usually come with higher interest rates.

Refinance the car loan

If your credit score has improved since you initially purchase the vehicle, you may be able to lower your interest rate and shorten the term of your loan. Both will help you get equity in your car sooner.

Whatever you do, be careful about trading in an upside-down vehicle for a new loan. Many car buyers opt to roll their negative equity from one car into a new loan because it doesn’t require coming up with cash to pay the underwater amount. But keep in mind this means your new car will be underwater before you even drive it off the lot.

How to avoid an upside-down car loan

Being upside down on your car loan is common, but these steps can prevent it.

  • Make a larger down payment: Cars depreciate by around 20 percent in their first year, so a down payment of at least 20 percent of the total purchase price (including taxes and fees) can help you avoid going underwater
  • Opt for a shorter loan term: Loans with long terms are more likely to be upside down because less of your payment goes toward the principal each month. So try not to finance a car for longer than you plan on keeping it.
  • Shop around for a low rate: The lower your interest rate, the more principal you’ll pay each month and the more likely you’ll be to have equity in the car.

Being upside down on your car loan is not ideal, but you do have options. Understand the circumstances that led you to be upside down in the first place and take action to prevent it from happening again. As long as you have equity in your vehicle, it will be an asset rather than an expense. That will give you more options if you need to sell or trade it in earlier than expected.

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