How to Get Out of a Car Loan

Most people can’t afford to purchase a car outright with cash. The principal financed amount and the interest paid based on the rate you qualify for comprise a car loan. These loans are also amortized, meaning your monthly payments go toward most of the loan’s interest before you tackle the principal amount. 

Learning how car loans work can help you confidently approach your next loan. When you determine what monthly payment you can afford and how to calculate car loan interest rates, you can select the best deals for a car you want to drive for more than a few years. While it’s true that cars are a depreciating asset, they’re often integral to our daily lives and necessary for commuting. Navigating car loans, however, can be tricky at times. 

What is an upside-down car loan? 

When a car loan is “upside-down,” you owe more on the car than it is worth. Being upside-down is also known as having negative equity. Upside-down car loans are less than ideal, especially if the car were totaled, you can’t keep up with payments, or you suddenly need a different vehicle. The sooner you can get right-side-up on your car loan, the better. 

Most car loans are upside-down initially because you haven’t made any payments yet. However, you can also get into an upside-down car loan if your down payment is too small, your interest rate is too high, or you add too many extra accessories or packages. 

Getting out of a car loan requires you to fulfill the loan agreement or terminate it early. You can fulfill the loan agreement by paying it off, trading the car in, refinancing it, or selling it. You can also negotiate new terms if the lender is willing to work with you. When you don’t fulfill your loan agreement, you typically come away owing money and with a damaged credit report. 

Doing some investigating while still paying on your loan can help you figure out which options are best for your situation. Request a 10-day payoff quote from your lender and your credit report (you get a free one each year). Check your loan agreement for prepayment penalties. Gather the information you need to understand what financials and timelines you’re working with. 

Continue paying (more) on your car loan

Many times, the best way to get out of a car loan without sacrificing your credit score is to continue to make payments. You can also pay extra each time (if your budget can handle it) to pay off your car sooner. This method is best when there are no prepayment penalties. It will take longer to get out of your car loan, depending on how far into it you are, but it’s often the safest option.   

Negotiate new terms

Suppose financial circumstances have changed to prevent you from affording your monthly payments. If this is the case, speak to your lender sooner rather than later. Come up with a game plan to offer them to maintain your loan agreement until you’re ready to assume full payments once more. It’s much easier to negotiate with your lender if you can agree to terms rather than default on your loan and incur hefty fines and legal fees. 

Get a personal loan

If you have a credit score of 670 or higher, you might be able to obtain a personal loan to float you along. You can use a personal loan for many things, which can free up funds to pay your monthly car loan payment. Remember that you’ll pay interest on a personal loan, so it might not be the best long-term solution. 

Refinance your car loan 

When you refinance your car loan, it’s similar to transferring a credit card balance to one with a lower interest rate. You’re paying less each month and in interest, but this arrangement often comes with additional fees. It’s best to weigh those fees and how they align with your ultimate game plan before jumping into a refinancing agreement. If your credit score hasn’t changed significantly (over 20-30 points), refinancing may not make sense or put you in a better position. 

Trade in the car 

If the car loan you’re paying on pays for your only car, trading it in can help you get into a more affordable car. However, you’ll have to roll your negative equity into that loan to balance the books. Trading your car is ideal if you can find an affordable car significantly under your monthly budget. That leaves just enough room for your negative equity payments required to pay off the first loan. 

Sell the car

Selling your car privately can earn you more for your ride, but working with a dealership is often easier. If you owe on a car you’re trying to sell privately, you must work out a deal and coordinate with the lender and buyer. This arrangement can scare off most potential buyers who want to purchase a car and be done with it. 

When you sell a car with negative equity to a dealership, they expect you to pay the difference or roll it into your new car loan. Neither situation is ideal, but cutting your losses and paying the negative equity can be the best. Taking on more debt doesn’t make sense if you can’t afford what you’ve already incurred.  

How to get out of an upside-down car loan

Getting out of an upside-down car loan requires considering what options you have available, including: 

• Paying extra: Think of the negative equity in your car loan as a balance you must meet before you can make money on selling your car. The more you pay each month (while remaining in your budget), the sooner you’ll resolve the negative equity. 
• Refinancing: With negative equity car loans, refinancing is a double-edged sword. If you have a higher credit score now, you can save on interest and lower your monthly payments, but you may end up paying more for your car than if you hadn’t refinanced, and you’ll have a hard pull on your credit report. 
• Trading in: Like refinancing, trading in a car can be tricky. If you can trade your car for one with lower monthly payments that fit your budget, you can come out on top. However, be careful not to roll your negative equity into the new car loan if you can avoid it. 
• Selling: You can use the proceeds from selling your car to pay off your loan balance, but if you have negative equity, you must come up with the difference. Selling your car and paying the difference can be worth it if you want to get rid of a car payment or save up for a cheaper car.

Look at your situation to see which option works best for you. The best option is to continue paying your loan, but if your financial situation changes, that might not be possible. Your ultimate goal should be to decrease negative equity as much as possible.   

Catching your inability to fulfill the terms of the car loan you entered early on can help you avoid lasting damage to your credit report. Taking preventative action can also save you hundreds, if not thousands, of dollars in fees, depending on how things could have worked out. Here’s how not to get out of a car loan if you can help it. 

Voluntary repossession

Voluntarily repossessing your car is better than ignoring your lender’s calls and forcing them to repossess the car themselves. It also costs less, though you will still be on the hook for several fees, including the deficiency. This deficiency is the difference between what the lender can sell your car for and how much you still owe on the loan. Voluntary repossession will negatively impact your credit score, but it looks better to future lenders than letting your loan go into default. 

Defaulting on the car loan

They say good things come to those who wait, but the opposite is true for letting your car loan default. If you wait until the lender repossesses the car to do something about your late car loan payments, you’re liable for hundreds of dollars in fees, penalties, and fines. 

That’s not to mention the damage defaulting does to your credit report. When you default on a loan, that mark stays on your credit report for up to seven years. This mark can significantly affect your ability to obtain another loan or qualify for anything credit-related. 

Opting for a car lease 

Going from a car loan to a car lease can feel like a great way to escape high monthly payments, but it’s often not the best long-term decision. Leases come with their own terms and fees, and adding negative equity to those costs can skyrocket how much you pay over the lease’s term. In addition, you typically walk away from a lease owning nothing, which can leave you in a lurch if you still need a vehicle to drive. 

If you choose to finance your car purchase, a car loan affects your credit immediately with a hard pull. However, that pull goes away in two years typically. Refinancing can incur another hard credit pull, but it’s much less than voluntary repossession or defaulting on your loan. Voluntary repossession can cost you 50 to 150 points on your credit score, while defaulting can have a severe and lasting effect.

You can buy a car without financing by paying for it in cash upfront. However, most people don’t have this luxury. Sometimes, paying for a car without financing might even be financially irresponsible. You’ll pay more in interest, but sometimes that cash can go further to help your finances in other ways. 

Paying for a car with cash can help avoid interest payments or credit checks. Some dealerships also offer discounts if you purchase a vehicle with cash. Alternatively, some dealerships do not accept cash payments. If you can pay for a car with cash, it’s best to consider the bigger picture before you start car shopping.