How to Get Out of an Underwater Car Loan

Being upside down, having negative equity or being underwater — these terms all describe a struggle millions of Americans face when owing more on their car loan than the vehicle is worth. This can be caused by high-interest rates, over-borrowing or rapid depreciation in a car's value.

Being underwater on a car loan can feel overwhelming, but understanding your options is the first step toward a solution.

In this article, we’ll help you identify if your car loan is underwater and what steps you can take to resolve the issue.

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What is an underwater car loan?

An underwater car loan means you owe more on your vehicle than its current market value. The term is used interchangeably with having “negative equity” or being “upside down” on a loan.

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Being underwater on a car loan can make it more difficult to refinance your loan, sell or trade-in your car or pay it off if it’s totaled because the loan amount is higher than your car's worth.

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To find out if you’re underwater on your car loan, you can use resources like Edmunds and Kelley Blue Book to check the current value of your car. If your loan balance is higher, you’re technically underwater.

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How do underwater car loans happen?

Understanding how you got underwater on your car loan is key to regaining control of your finances.

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The most common causes for negative equity on a car loan include:

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• No money down purchases: Buying a car with a small down payment means the loan starts close to the car’s value, leaving little room for depreciation.
• Long-term loans: Extended loan terms — 60 months or more — often come with lower monthly payments. However, this can lead to negative equity as depreciation outpaces loan payments.
• Rapid depreciation: Cars can lose around 20% of their value in the first year. This loss of value often outstrips loan payments, leaving you upside down on your loan.
• Overpaying for the car: Paying more than the market value for a car increases the likelihood of negative equity.
• High-interest rates: Loans with high interest make it harder to reduce the principal balance quickly, prolonging negative equity.
• Roll-over loans: Transferring negative equity from one vehicle loan to another can result in starting off with an underwater loan.

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These, and other factors, can increase your chances of an underwater loan.

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What to do when you're underwater on your car loan

If you're underwater on your car loan and don’t know what to do, you have options. These include refinancing for better terms, paying off the loan, making extra payments, selling your car, trading it in for a cheaper vehicle or surrendering it to the lender.

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You might also consider negotiating with your lender for a more manageable payment plan.

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1. Pay off your loan

The simplest way to get out of an underwater car loan is to pay off the loan in full. You can do this if you have the cash available or can secure a loan to cover the remaining balance.

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Paying off your loan eliminates the negative equity and allows you to own your vehicle outright. If paying off the balance isn’t feasible, consider refinancing, selling your car or other options.

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2. Refinance your loan

Refinancing means taking out a new loan to pay off your existing one. It can be a practical way out of negative equity. The goal of refinancing a car loan is to secure better terms, such as a lower interest rate or an extended repayment period.

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If you decide to refinance, here are the main steps in a typical process:

1. Check your credit score: A higher score can help you qualify for better rates.
   
   
2. Shop around: Research lenders offering competitive rates. You can use our auto loan refinancing calculator to compare terms.
   
   
3. Gather the documents: After selecting a lender, prepare the documents required for the application process.  Your lender may request proof of income, current loan information and vehicle details.
   
   
4. Apply for the new loan: Submit applications to your chosen lenders, providing documentation as necessary.
   
   

Review terms: If approved, carefully read the new loan agreement before signing. Finally, your new lender will pay off the original loan and you’ll begin payments under the new terms.

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3. Sell your car

Selling your car can help you out of an underwater loan — if you use the proceeds to pay off the balance.

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If the sale price covers the remaining balance, you’re free from the loan. However, if the car’s sale price is less than what you owe, you will have to pay the difference.

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4. Surrender your vehicle

Surrendering your car means voluntarily returning it to the lender to settle the debt.

When you surrender your vehicle, you may still owe money if the sale of the vehicle doesn’t cover the remaining loan balance.

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This is not an ideal solution, but cooperation with the lender is generally rated better than repossession, so it tends to be less damaging to your credit score.

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Avoiding an underwater loan

As you learn how to get out of an underwater car loan, here are simple actions you can take when purchasing your next vehicle:

• Understand car depreciation: Some models lose value faster than others, so select a car with a strong resale value.
  
  

• Make a large down payment: A reduced loan balance will help you avoid owing more than the car is worth.

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• Choose a shorter loan term: A 36- or 48-month term can reduce your exposure to depreciation and help you pay off the loan faster.
  
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• Avoid overborrowing: Only borrow what you need, what you can afford and don’t splurge on unnecessary features or upgrades.

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FAQs

These frequently asked questions can help you understand — and deal with — underwater car loans:

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What is an underwater or upside down car loan?

Also known as negative equity, an “underwater” or “upside down” car loan is when you owe more on your vehicle than it's currently worth.

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This can happen due to rapid depreciation, a low down payment, high-interest rates or other unfavorable financing terms.

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How to get out of an underwater car loan without hurting credit?

To escape an underwater car loan without damaging your credit, you have options that include refinancing for better terms, negotiating with your lender or making extra payments to reduce your balance.

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Selling the car or trading it in for a cheaper vehicle are also ways out of an underwater loan — although this can mean taking a loss to get your loan fully paid off.