Refinancing is replacing your current auto loan with another one, hopefully with more favorable terms. Most borrowers look into refinancing to lower their interest rate or lower their monthly payment. Refinancing an underwater (negative equity) car loan isn’t likely to happen, but there are ways to catch your breath and get your loan above water.
How to Pull Your Car Loan Above Water
When you’re underwater on your auto loan, refinancing is out of the question until your loan balance is equal to your vehicle’s value or you owe less on your loan than it’s worth. This means that if you default on the loan, the lender can't get enough out of a sale at auction to cover what you owe on the loan. They do this as a precautionary measure.
In order to know how far underwater your loan is, you need to find out the value of your car, and compare it to how much you owe. Before you try to refinance, check your vehicle’s value using online valuation sites like Kelley Blue Book, Black Book, and NADAguides. These sites can give you an estimate of your car’s value so you can compare these values to your loan balance.
To get out of negative equity, the answer could be to simply continue paying as normal until you catch up with your vehicle’s value. Or, you can pay off your loan faster than what was planned if you want to refinance quicker. Of course, paying off your auto loan before it was scheduled can be easier said than done.
You don’t have to have large sacks of money laying around to pay off your loan faster – there are little things you can do to relieve the burden of negative equity and work toward refinancing:
- Split payments – If you pay half of your car payment every two weeks, you end up making 13 monthly payments in a year instead of just 12. This also lowers your interest charges because you’re lowering your loan balance faster.
- Rounding up – Some borrowers round up their vehicle payment each month to pay it down quicker. Say you have a payment of $217. You can round that up to the nearest 50, $250, so that you pay an extra $396 a year on your auto loan.
- Lump sums – Whenever you get windfalls of cash, like a tax refund, you can use some or all of it to pay down your car loan quicker.
- Combination of all – You can do all of these things together to pay down your vehicle that much faster. Round up your payment, use payment splitting, and use windfalls to pay extra. You can also pay extra whenever you can.
What Causes Underwater Auto Loans
It can be hard to catch up with negative equity if you have a high interest rate, a high loan amount, and a long loan term. There are two big players that can cause negative equity: depreciation and interest charges.
Depreciation is the silent killer of your car’s value. Over time, your vehicle loses value, and if you’re not paying fast enough to combat depreciation, you risk being in a negative equity position.
Your interest rate can cause negative equity too. With a high interest rate, it can be harder to keep your auto loan above water. A high interest rate is a big motivator for borrowers to get into an equity position so they can refinance and qualify for a lower interest rate.
Because nearly every car loan uses a simple interest formula, the quicker you pay off your loan, the more you save overall in interest charges, since they accrue daily based on your loan balance.
Requirements of Refinancing a Car Loan
Now that you know how to get out of an underwater auto loan and what causes negative equity, it’s time to look at the other common refinancing requirements.
Lenders vary in their specific refinancing standards, but many require that:
- Your vehicle has less than 100,000 miles
- Your car is less than 10 years old
- You’ve had the auto loan for at least one year
- You don’t owe too much or too little on the loan (depends on the lender)
- Your credit score is good, or better than it was when you first got the car loan
- You’ve stayed current on payments throughout the loan
When you apply for refinancing, the lender you’re applying with looks at all these factors to determine if it makes sense to rework your auto loan. Besides the equity position qualification, lenders have these requirements to determine if it makes sense to approve you for refinancing. Typically, they don’t want to refinance a car loan that just started, or one that’s almost over with.
Refinancing lenders also want to see that your credit score is good or has improved since the start of the auto loan, since that means you’ve been handling your loan and other aspects of your credit history well. Your credit score doesn’t necessarily have to be good to refinance – usually it just needs to be better than it was when you started the car loan!
Finding Bad Credit Auto Loan Resources
Whether or not you’re ready for refinancing or you want to get into another vehicle, we can help at Auto Credit Express.
To get connected to refinancing auto lenders that can work with your credit situation, click here to look for the right refinancing lender. Our trusted partner can help you view and compare refinancing offers online.
If you want to find a bad credit car lender, start by completing our auto loan request form. We’ve created a nationwide network of dealerships that are signed up with subprime lenders. These lenders assist borrowers with vehicle financing when bad credit and other unique situations get in the way. Get started today!