Skip to main content

Why You Might Be ‘Underwater’ on Your Car Loan – and What You Need to Know

According to the National Automobile Dealers Association, roughly four out of every five Americans who buy new cars take out loans in order to do so. And the value of a new car drops – depreciates, in industry lingo – as soon as you drive it off the lot, and continues to do so over time.

Together, those two realities can come together to result in cars being worth less than the balance on their loans. And that could be problematic, especially if the car suffers serious damage in a crash or you want to sell it.

Car loans, like mortgages, are amortized, which means that a larger portion of your payments goes toward interest rather than principal early in the loan term. As a result, if you financed your car – especially if you used a longer loan term to do so – you could find yourself with negative equity, referred to colloquially as being “upside down” or “underwater” on your car loan.

Further, in order to keep monthly payments manageable, especially as interest rates have increased over the past few years, many borrowers choose to finance their cars for longer periods of time. Lenders are increasingly offering 72-month, 84-month and even 96-month loan terms. That can increase the odds that you’ll still be paying the loan off when you want to sell the car – which by then could be up to eight years old, and so considerably depreciated in value.

What to do if you’re underwater on your car loan

It’s not necessarily a terrible thing to owe more than your car is worth, especially if you plan to drive it for a long time. But if you want to trade in your car or get a new loan, you could have some tough decisions to make. You could either pay out of pocket or roll the outstanding loan balance into your new loan, if your lender allows it.

One of the biggest risks to being "underwater" on your loan is in the event the vehicle suffers significant damage in an accident or is stolen. If you have collision or other than collision coverage and your car is "totaled," your insurer will pay the current value of your vehicle. Keep in mind, this isn't the original purchase price for your vehicle but rather the current value, which takes into account any depreciation that occurred after you purchased your car.

While depreciation happens at different rates for different makes and models, some vehicles can depreciate by 20% or more in the first year alone. If your car is totaled early in your loan term, there could be a gap between what your insurance company pays out and the balance remaining on the loan. This makes you responsible for paying the difference – an amount that could potentially be thousands of dollars. What’s more, this is on top of your car insurance deductible, which will be deducted from the amount your insurer reimburses you.

Luckily, Amica offers a solution to avoid having to pay out of pocket in situations like this. Gap insurance, as the name suggests, fills in the gap between an insurer’s payout for a totaled vehicle and the remaining amount owed on a car loan. Gap coverage picks up where your collision and other than collision coverage ends, so you need to have collision coverage first. (Most lenders require that you carry both, including collision and comprehensive, until the vehicle is paid off.) Gap insurance will make up the difference between the vehicle’s fair market value and the principal amount you paid to purchase the vehicle. If you rolled over a balance you still owed on your last car loan into your new vehicle loan, gap insurance does not cover any rolled-over balance you still owe.

In addition to getting financial protection and peace of mind with a gap insurance policy, there are a few steps you can take to reduce the time spent “underwater” or avoid owing more than the car’s value in the first place.

  • Choose a car model that depreciates more slowly.
  • Borrow for a shorter term so you can pay down the principal more quickly.
  • Refinance your car loan. If you refinance your loan at a lower interest rate without extending the term, you can pay down the principal more quickly.
  • Make extra principal payments to pay off your loan more quickly. If you do this, make sure that your lender won’t hit you with an early payoff penalty.

Get an auto insurance quote

or call 833-513-3881

This story was created in partnership with Money.com.
 

Your Policy, Policy Declarations or Amended Declarations in effect on the date of loss is the primary source of reference for your coverage, coverage limits and deductible amounts.

This inclusion of non-Amica companies, products, services or statement herein (“Third-Party Content”) is for general informational purposes only and does not constitute a recommendation or endorsement by Amica Insurance. Policies, views, opinions or positions of Third-Party Content expressed herein are those of the authors and do not necessarily reflect the policies, views, opinions or positions of Amica Insurance. Amica Insurance makes no warranties, expressed or implied, as to the accuracy and reliability of Third-Party Content.

This content may contain helpful tips, explanation and advice. Your use of this information is voluntary and may not be effective in every circumstance. Amica encourages you to use good judgement and put safety first.

For more information on our editorial process and content standard, take a look at our editorial guidelines.

 

AMIC-02-040325