You have probably heard the old joke that a car loses value the second after you drive it off the lot. Guess what? Edmonds did some research and found it’s not a joke. They showed how a new $29,873 Nissan dropped in value by $2,559 – about 9 percent – in a matter of minutes. The study also showed the new car depreciated by 19 percent in the first year and 42 percent in three years. That’s a loss of $12,467 in thirty-six months – or $346 a month!
A driver who puts no money down, or traded their car in with negative equity, quickly finds themselves underwater in their vehicle – meaning they owe more than the car is worth at any given time. You are reading this so I am assuming you want to know how to prevent a car from being underwater – and I don’t mean avoiding lakes and boat piers!
Here are three ways to get out of an underwater car.
Aggressively pay down the balance
Pay early, often, and with excess! In other words, send every dollar you can to pay down the balance. Continuing to do this will help you catch up to the decreasing value while it’s in the dip. Once the amount of your loan is lower than the value, list the car for sale. That’s the quickest and easiest way to get out from an underwater car.
Statistics show you will get more money if you sell the car as an individual rather than to a dealer or at auction.
Note: When sending extra payments to pay down the loan, make sure it is being applied to paying down the principle – not pre-paying the interest. If you mail a paper check then be sure to include your account number and a note in the memo line that says “Apply to principle, not interest”. If you are paying online then be sure to add a note, if applicable, and check a few days later to ensure the pre-paid principle was applied properly.
Save up the difference
Instead of paying down the balance, you could save up the difference. For example: You owe $20,000 but the car is worth $16,000. As you make normal monthly payments you save up $4,000 in cash. At this point you can sell the car, take the $16,000 from the sale and $4,000 cash in order to pay off the car loan, and provide the new buyer the title.
Note: You can provide the buyer a Bill of Sale while waiting for the title to be delivered.
Warning: There are pros and cons for saving cash to pay the difference: The cash could be used in case of an emergency, but it also could be spent on something other than paying down debt.
Pay it off completely
This is the hardest and the easiest choice to make: Pay off the car early.
It’s the hardest choice because it will take longer to pay off the entire loan. However, it’s the easiest because you don’t have to sell your car and find a replacement vehicle.
I would also challenge you to use the “2x Rule” if you decide to keep the car. What’s the 2x Rule? It is a requirement to keep the car for twice as long as it took to pay it off. For example, if it takes you 4 years to pay off the car then raise your right hand, place your left hand on a Bible, and swear to keep the car for a total of 8 years.
This may seem crazy, but so are monthly payments we make for something that spends the majority of the day in a garage, driveway, or parking lot. That’s right, you are paying a premium for parking!
You don’t have to have a car payment
We paid off my wife’s SUV in 2007. In April, I paid cash for a gently used Honda Civic.
We haven’t been underwater on a car for over a decade. The cash flow in our budget has been amazing. We have paid cash for vacations, a kitchen remodel, and replaced all the windows in our house. Cars no longer have a handcuff on our paychecks.
Our net worth continues to grow because we no longer borrow money for vehicles. It may sound like I’m bragging but please hear my heart: Your life will become richer when are no longer underwater with your car.