What To Do If You Have an Upside-Down Loan

When You Owe More Than You Own

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An upside-down loan is a loan balance that exceeds the market value of your car or home. In other words, you owe more than you own. This often happens when something you buy with debt loses value faster than you pay down the loan balance.

Learn the details behind getting upside down on a loan and how to solve the problem.

Upside-Down Auto Loans

With most standard auto loans, you pay down your loan balance over a set period of time. A portion of each monthly payment goes toward interest costs, and the remainder goes toward the loan balance. Eventually, you pay off the car loan balance entirely. This process is called amortization.

Auto loans can go upside down when the vehicle loses value faster than you pay down the loan balance. For example, a brand new car might cost $25,000. A few years later, it might only be worth $15,000 (cars tend to lose their value quickly). If you still owe more than $15,000 on your auto loan at that point, you have an upside-down car loan. If you were to sell the vehicle, you might have to pay money—by writing a check, for example—since you may only be able to get $15,000 for it, but owe more than that on the loan.

To avoid this problem, you need to pay down the loan (or have it amortize) faster than the vehicle loses value.

When it comes to buying a car, the rule of thumb is that it’s best to get a loan that lasts four years. Longer terms—like six- and seven-year loans—can help keep monthly payments low, but you risk being upside down toward the end of your loan.

Upside-Down Home Loans or Underwater Mortgages

Most people expect property values to rise over long periods of time, but that’s not always the case. Home values can fall for a variety of reasons. Major economic events like a recession can cause homes to lose value, and local factors can impact smaller areas. Even an individual home in a strong market can lose value if there are structural problems or other issues unique to that property. If your home’s value drops, and you owe more on your mortgage than the property is worth, you’ll be upside down on that home loan.

Reverse Mortgages

Price changes aren’t the only risk. Certain types of mortgages can pull you "underwater"—another term for being upside down on a loan—if your loan balance increases over time. When you don't pay enough each month to cover the interest charges on your loan, those costs can be added to your loan balance. That’s particularly likely when you don’t make any payments, as with a reverse mortgage.

When using a reverse mortgage, being underwater might not be catastrophic. In many cases, you or your heirs do not have to pay off the loan balance but check with your lender to avoid any surprises.

What Happens If I Sell My Upside-Down Car or Home?

Auto Loans

If you’re upside down on a vehicle, you have several options for selling. If you can pay off the amount you owe, that’s ideal. Contact your lender to discuss the logistics of paying off the loan in combination with selling the vehicle. If you’re trading in your car or financing the purchase of another car, it may be possible to add the amount you owe to your new auto loan. 

Rolling an old car’s debt into your new vehicle loan can be risky. You’ll have an upside-down loan from the start, so you don’t really solve the problem. Eventually, you’ll have to pay off that debt, but this strategy can help buy you some time.

Home Loans

If you’re underwater on your home loan, you may still be able to sell your home. A short sale enables you to sell the property for less than you owe with your lender’s permission. The question is whether or not you’ll need to repay the difference between the amount you owe and the amount your home sells for.

In some states, known as non-recourse states, you might not owe any money for the “deficiency”—the shortfall when the property’s market value is less than your loan balance. However, in many states, lenders can attempt to collect the difference from you. That means the loan could linger long after you complete the sale. A licensed attorney may be able to help you in this instance.

How to Handle an Upside-Down Loan

If you find yourself with an upside-down loan, you've got difficult decisions to make.

Keep Your Property and Pay Off the Loan

One option is to keep your car or home and continue paying down the loan. Unfortunately, that's not always feasible. Expensive repairs can make a vehicle more trouble than it's worth. Or you might need to relocate and sell your house for a variety of reasons. 

When you’re dealing with an upside-down car loan, it might make sense to use gap insurance to manage your risk.

Sell—and Pay

Another option is to sell—just to put an end to things. The bad news is that selling won't bring in enough money to pay off your loan, so you'll have to come up with the remaining cash or risk a deficiency.

If you're selling the car, it might be best to sell it yourself. You might be able to sell the car for a higher price to a private buyer than to a dealership.

Work It Out

You may be able to work out a plan with the help from your lender. Discuss your situation with them and with loan officers from a local bank or credit union. One option might be to sell your car and pay off the remaining balance over time. You can also consider voluntary repossession. You won’t have a vehicle anymore, but if the sales proceeds pay down your loan balance, you’ll have less debt to pay off.

Always think about how the option you’re considering could impact your credit score.

Make Extra Payments

It’s easier said than done, but if you have extra money available, it could make sense to use it to pay down the loan balance faster. Doing so may provide flexibility, and allow you to sell if and when you need to (without getting your current lender’s permission).

Refinance

If you’re borrowing at high interest rates, it could make sense to refinance into a better loan. If you qualify for lower rates, you’ll pay less interest each month. As a result, your payments can potentially make a bigger dent in the loan balance, and you may get back above water sooner.

The Bottom Line

When you owe more money on something than it’s worth, it’s called being upside down—and you’re in a difficult position. There are typically several options for getting out of an upside-down loan, but none of them are attractive. It’s ideal to pay off underwater loans out of pocket, but that’s not feasible in most situations. If something comes up (and you need to sell your car or home before you can pay down the debt), contact your lender to discuss your options.