Upside Down: Trading in a Car with Loan Debt

Trading in a car when you owe more money than it's worth can lead to some dangerous predicaments but luckily it's not always such a bad idea.

Upside Down: Trading in a Car with Loan Debt

Unless you’re able to wander into a dealership and throw a stack of cash up to your knees at a car on the lot, drive it into a telephone pole, return to the dealership and repeat the process, then you’re probably going to finance. The thing to remember about financing a new car is, it’s going to be underwater for some amount of time unless you pay a large enough down payment.

Having An Underwater Car

When your car is underwater, it means you owe more money than the car is worth. If something like repossession were to happen to you during the underwater period, then you’d be in trouble because when the car is sold at auction, you still need to pay off the rest of the loan.

Why is your vehicle underwater? Because new vehicle depreciation is a mystical vacuum not unlike a black hole, where suddenly your car is worth 20% less just for driving it a few feet.

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When Being Underwater Is An Issue

Being underwater is only a real problem if you plan on trading in to get a new car after only a couple years, or, during that underwater period, because then you get into a nasty cycle of rollover debt.

This happens when you sell the underwater car or trade it in to get a new car, and the remaining debt is carried over and added to the loan you get in order to pay for your new car. Unless you stick it out with your new car, you’ll be trapped in the whirlpool of rollover and stay in debt for a long time.

What You Can Do About Being Underwater

This is no reason to panic. It happens to everyone who finances a new car, and unfortunately, the only way to get out of it is to keep up with monthly payments and ride it out. There is a time when after about five years the depreciation levels out, and if you’ve taken good care of your car you can probably sell it for a bit more than it’s worth at that point.

After about five years, a car depreciates as near as makes no difference to 60%, but if the car is in good shape and has average mileage at most, you stand a good chance of getting a decent deal if you decide to sell it.

You can avoid a long period of underwater time by buying used, as you skip over most of the depreciation and don’t have to deal with it. The most important thing about being underwater is, keeping up with the payments until you surface.

This is why meticulous research is paramount when shopping for a new car. Make sure you know what you’re getting, know what you’ll like and dislike about the cars you’re considering, and test-drive a lot of different kinds. No matter what happens though, it’s in your best interest to keep the car at least until it’s out of that underwater period.

Brian GrabianowskiBrian Grabianowski

Avid Formula 1 fan and motorcyclist, I enjoy chocolate chip cookie dough ice cream and long rides to the beach.