Being Upside Down in Your Car can be Uncomfortable

by Murray Anderson

Ever think you might end up upside down in your car? No I'm not talking about a crash and a rollover (nobody wants to think about that). I'm talking about just driving along and not even realizing you're upside down.

How can you be upside down in your car and not know it?

Being upside down (or underwater) are descriptive terms used in the car business to describe someone who has negative equity in their car, - in ordinary language, they owe more on their vehicle than it's worth. In the real world this is the kind of situation that can happen quite easily, particularly with dealers offering zero down payments plans, low interest loans and payment schedules stretching over 60, 72 even 84 months.

Remember, the value of a new vehicle goes down quickly in the first few years it's on the road and the worth of your car can go down faster than you're building equity (ownership) in it. Your early car payments go to paying a large part of the interest owing on your vehicle with little going against the actual amount owed on the car itself, so you don't build up much equity in your vehicle.

It's easy to get into this situation if for example you decide to take advantage of a dealer's offer to roll your existing car loan into the amount owing on a new car. You haven't paid off your first vehicle and the outstanding balance is now owed to the dealer in addition to the new obligation for your new vehicle. In this case you're upside down before your drive off the lot.

Or let's say you need a new car, but don't want to make large monthly payments so you take advantage of a dealer’s kind offer to spread your payments over 72 months. A year into your ownership and you've made 12 payments and still have 60 to go. Since a new car looses something like 20% of its value in the year its on the road, your car retains approximately 80% of its original value while you've only paid 16% of your obligation. You're upside down, and let’s not forget that a lot of that money actually has been applied to financing charges, not applied against your amount owing.

It sounds like everybody gets upside down - what's the problem?

Many people are upside down in the early years of a new car purchase and it isn't a problem as long as they keep the car until their equity at last matches the market value of the vehicle.

However, let's say your circumstance change, you miss a few car payments and the dealer takes it back. You're still responsible for the total amount outstanding on the loan, not just the value of the car. So now you've got no car and a sizeable debt.

Or you're in an accident and your car is totaled. Insurance generally pays the book value of a car, so it won't give you enough to pay off your loan. In this case, you don't have a car, your insurance won't pay enough for you to replace it and you still have to come up with some cash to cover off the outstanding balance.

So you see, being upside down can be very uncomfortable.

How to avoid getting upside down in your car.
Try to make a sizeable down payment when purchasing. The more you put down, the less you will owe over the life of the vehicle.
Don't stretch you payments out too long. Small monthly payments are a strong inducement but paying for a car over 72 months means you'll be likely be upside down for at last a few years.
If the terms of your loan agreement allow you to, make extra payments against the principal whenever possible. This will save you interest charges and shorten the length of your loan.
Don't roll an outstanding from one car onto a new one. This increases the amount owed in total and virtually guarantees you'll be upside down for a long time.

Being upside down in a car purchase isn't the end of the world, and lots of people are in that situation for a while when buying a new car. The trick for your financial health is to make sure you get out of that uncomfortable position as quickly as possible.