How to trade in your car if your loan is underwater

By ,
Ask a Lender
January 26, 2017 | Updated September 26, 2017


Key Points

How to trade in your car if you owe more than it’s worth

  • Pay down the loan to reverse the car’s negative equity.
  • Refinance the car into a loan with lower interest.
  • Roll over the negative equity into a new car loan.

After watching some flashy advertisements showing the shiny new cars you can get by trading in your old clunker, you may be tempted to take advantage of the offer. But is that even possible if your car loan is underwater — that is, do you owe more on the car than it’s worth?

While an underwater loan — also known as an upside down loan or a negative equity loan — might make the chances of successfully trading in your vehicle somewhat slim, you still have a couple options.

Pay down the loan

The smartest option is perhaps the least desirable for borrowers who are eager to quickly exchange their rusty clunkers for shiny new cars. Being patient, however, can pay off. Continuing to make payments on the loan will drag it out of the water, so to speak, and leave you on stronger ground financially.

If you want to move the process along, pay more than the minimum monthly payment if you can do so. The more money you pay on the loan, the more equity you build in your vehicle, and the faster you’ll reverse your negative equity.

Refinance your auto loan

If your auto loan is underwater, you may want to consider refinancing into a shorter-term loan. Although refinancing into a shorter-term loan might increase your monthly payment, you can secure a lower interest rate. If you’re able to refinance to a lower interest rate but keep the same loan term, your monthly payments might actually be lower.

Unfortunately, it’s unlikely that a bank would refinance a car that is worth less than what is still owed, which brings you back to the strategy of paying down the loan. Once you get the loan under control, and you owe less than what the car is worth, you can seek refinancing to get a lower interest rate.

Roll over into a new loan

If you absolutely must trade in your car for a new one, you must roll the remaining balance — i.e., the balance not covered by the car’s trade-in value — into your new car loan.

For example, let’s say your car has a trade-in value of $2,000, but you still owe $5,000 on it. If you take out a loan for a new car — let’s say, for $15,000 — then the difference between the trade-in value of your old car and what you still owe on it, $3,000, must be added to the loan, making it $18,000.

This is easier said than done, however, because not many lenders are open to finance a pre-owned vehicle for a price significantly more than it is worth, because, should you default on the loan and the bank is forced to repossess and sell the vehicle, they won’t be able to recoup the outstanding balance. If you finance the vehicle through a car dealership, especially if you’re purchasing a new car, they may be more open to rolling over the outstanding balance into a new loan.

Take out a personal loan

If your car loan is underwater, one option may be to take out a personal loan to pay off the difference between what your car is worth and what you owe. Then, once the balance is on steadier ground, you can refinance the auto loan, or trade in the car. The obvious downside to this strategy is that you will then have an extra loan payment to make each month.

One solution is to lease a car instead of financing one. Although you won’t get to keep the car at the end of the lease period (unless you decide to buy it), the monthly payments are often lower on a lease than they are on a loan. You may be able to manage a monthly lease payment, along with a payment on the personal loan you used to restore the equity in your previous car.

Compare Auto Lenders