An upside down car loan is the result of owing more on your car than it is worth. The best way to avoid this frustrating financial situation is to understand upside down car loans and how they happen.
Defining Upside Down Car Loans
An upside down car loan, also known as a loan that is underwater, is when your car’s financing arrangement culminates in you owing more than the car is worth, or having negative equity in the vehicle. Negative equity is the result of investing more money in an asset than it is able to bring in on the open market.
Assets like cars that depreciate in value quickly are more likely to suffer from negative equity, especially when a car loan is in place. Cars depreciate in value rapidly. As soon as the car leaves the lot a substantial amount of the car’s value is immediately gone. From there, every mile driven decreases the car’s value more. If the depreciated value of your car is less than what you owe after internet is added to your loan, your car loan is considered upside down.
How Upside Down Car Loans Happen
There are a few primary causes of an upside down car loan. The primary cause is the ratio of the car’s depreciating value versus the outstanding balance of the loan still owed to creditors. For example, if your car has depreciated to a fair market value of $5000 and you owe $5500 on your car loan principal, your loan is considered upside down.
Your car’s rate of depreciation can be expedited due to a number of factors, some of which are entirely outside of your control. The rising cost of fuel has contributed to the resale value of vehicles with low gas mileage to drop drastically in recent years. In other words, as gas gets more expensive a fuel-inefficient vehicle will depreciate faster. Other factors that can speed up your car’s rate of depreciation are excessive miles driven, poor maintenance habits, and bad consumer reports.
A low down payment can also instigate an upside down car loan. The financing terms of your car loan are based on the outstanding balance after the initial down payment. When you do not put down enough money upfront, the financing terms you receive can immediately put you in an upside down car loan.
An upside down car loan can have a negative impact on the equity you have in your car and results in you owing more than the car is actually worth. Be aware of what causes an upside down car loan before deciding on financing options.
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