How to Avoid the “Upside Down” Auto Loan Trend

Being “upside down” in a loan simply means that you owe more than the car is really worth.  Unfortunately, falling car prices have put more people in this position than ever before.  However, there are a few steps that you can take to avoid this problem.

Initially, be careful with your choice of the car.  If you’re looking at cars in an investment light, seek cars with a high resale value.  While it’s true that every car begins to lose value as soon as it rolls off the lot, choosing a car with a good resale value will make this a bit easier.

Also, consider a used car that’s at least two years old.  Thirty to forty percent of an automobile’s depreciation occurs within the first two years.  Past that period, the loss is manageable and can be easily exceeded by regular payments.

Another tactic is to make as large a down payment as possible.  Use the old twenty percent rule as a base and then try to go over that by as much as you’re comfortable with.  The more you put down on the front end, the farther you’ll be from the “upside down” state.

You can also look at the terms of the financing.  Go for as short a term as possible, with the highest payments you can swing.  This way, there’s a monthly step that you can take that will continually put you in a better situation.

If you do find yourself upside down on the loan, keeping the car a bit longer than you originally intended to can be enough to reverse this situation.  The closer you are to paying off the car, the more value you have in the car, since you’re paying more to the principal than on interest at the end of your loan.

A bigger risk when you’re in an “upside down” loan is what would happen if the car were totaled in a wreck.  The difference between what you owe and what the car was worth would fall to you.  For this reason, you should consider gap coverage, which will cover the difference between the value of your car when it’s totaled and your outstanding loan balance.  Remember, you’re responsible for paying that difference even if your car is a complete wreck

You should know that, depending on where you live in and the type of coverage you have, your insurance deductible may be covered too.  Gap protection isn’t exactly insurance, though that’s what most people call it.  Strictly speaking, it’s a debt cancellation agreement – it waives the part of your financing agreement that makes you responsible for the difference between the value of your totaled car and the loan balance.  No matter what it’s called, this protection will satisfy your liability.

However, gap coverage is a big step that you may not need.  If the difference between your car’s value and what you owe isn’t that big – say one and a half times a monthly payment – you may be fine if the car is totaled.  In any event, this coverage will only go into effect if a car is a total loss, so you’d still be on the hook for most repairs and minor damage.