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Auto Loans

How to Get Out of a Car Loan You Can’t Afford

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For many people, a car provides necessary transportation for work, school or other everyday needs. But if you're struggling to keep up with your payments, you may be wondering how to get out of the loan.

There are a few options you can consider, including selling the vehicle, working with your current lender and refinancing your car loan. Before you go down one of those paths, though, it's important to understand how each works and how it can affect your finances as well as your credit.

How Do Car Loans Work?

A car loan is a secured installment loan you can use to purchase a vehicle. The car itself is used as collateral to secure the loan, which means the lender can repossess the vehicle to recoup the loan amount if you stop making your payments.

Because car loans are installment loans, the borrower makes equal monthly installment payments until the loan is paid in full. Car loan repayment terms can range anywhere from 12 to 84 months, though the average length is roughly 72 months for new cars and 65 months for used ones.

A car loan's interest rate, which is based on your credit score, income and other factors, applies for the entire life of the loan. When you borrow to buy a car, the lender calculates how much you have to pay in principal and interest each month to reach a zero balance at the end of your repayment schedule. A lower interest rate can help reduce how much you'll have to pay.

You can get a car loan from a number of places. Banks, credit unions and vehicle manufacturers are the most common sources of car loans. You may even be able to secure financing directly from the dealership ("buy here, pay here"), but that's not usually a great option. In some cases, you can apply for a loan directly from a lender, and in others, your lender may arrange financing on your behalf.

What to Do if You Can't Afford Your Car Loan Payments

During the financing process, it's important to consider your budget to make sure you can afford the vehicle you're buying. But financial situations can change and you may now be finding it difficult to stay on track.

If you're having a hard time making your monthly payments, here are some potential ways out.

Consider Selling the Car

Getting rid of your mode of transportation isn't ideal, but if you can't stick to your repayment schedule, you may lose the vehicle anyway. By selling it, you can be in control of the process, and you may be able to get enough cash in the sale for a down payment on a less expensive car.

Alternatively, you can visit a dealership and see if you can trade in your car to cover part of the purchase price for a cheaper vehicle. Just keep in mind that you'll usually get less money with a trade-in than by selling your car to a private party.

Negotiate With Your Lender

Depending on your situation, getting out of your car loan may be overkill. Call and speak with your lender about your situation and see if you can make a deal.

For example, if your financial challenges are temporary, you may be able to negotiate a forbearance, which pauses your payments for a short period. Your lender may also offer to modify your monthly payment amount to make them more affordable until you can get back on your feet financially.

Each lender has its own policies for people experiencing financial hardship, so contact your lender to see which options are available.

Refinance Your Auto Loan

Refinancing your car loan can help in a couple of ways. First, if your credit score has improved or market interest rates have gone down, you may be able to score a lower rate than what you're paying right now, which will lower your payment amount.

Second, you may be able to refinance into a loan with a longer repayment term. Spreading out your payments over a longer period of time will make them more affordable each month. At the same time, though, you'll ultimately pay more over the life of the loan.

When refinancing your auto loan, you'll want to shop around for the best interest rate to ensure the biggest savings in your finance payments. Also, consider the potential cost of fees associated with the new loan, government paperwork and if your existing loan has a prepayment fee that's charged if you pay off the loan early.

Voluntarily Surrender the Vehicle

If you've defaulted on your auto loan, the lender may choose to repossess the car. The process isn't pleasant, and it can wreck your credit score. If you want to avoid repossession, but you have no other options, you can voluntarily surrender the vehicle to your lender.

A voluntary surrender allows you to return the vehicle to your lender on your terms, and while it can damage your credit, it won't have as big an impact as a repossession. You'll also be able to avoid certain repossession-related costs, which lenders may choose to add to what you owe. If you feel as though this is your only option to avoid a repo, contact your lender to set up a time and a place for the vehicle to be turned in.

How Will Getting Out of a Car Loan Affect My Credit?

The ways getting out of a car loan can affect your credit depend largely on which path you choose:

  • Selling the car: If you sell your car and pay off the loan in full, it won't have much of an impact on your credit score at all. That said, if you replace your loan with a new one on a cheaper car, the hard credit inquiry may temporarily lower your credit score a little.
  • Negotiating with your lender: Depending on what you and the lender end up deciding, it may or may not impact your credit score. If you get approved for forbearance, your lender likely won't report that to the credit bureaus. However, if you get on a longer-term modified repayment plan, it may report that you're no longer making payments as originally agreed, which could impact your score and how future lenders view you.
  • Refinancing your auto loan: As with replacing your current car with a new one, refinancing your car loan will impact your credit when you apply for the loan. That said, in most cases, one new hard inquiry won't take more than five points off your credit score, if it affects your score at all.
  • Voluntarily surrendering the vehicle: If you have no other options but to give up your car, you won't be able to avoid damage to your credit score by voluntarily surrendering the vehicle. By the time it occurs, you've likely already missed some payments, which can wreak havoc on your credit history, and have been threatened with repossession. However, giving up the car instead of waiting for the lender to seize it may look better to lenders reviewing your credit report in the future.

How to Avoid Going Upside Down on a Car Loan

Being upside down on a car loan occurs when you owe more than the car is worth. It's also called being underwater or having negative equity.

If you're upside down on your car loan and sell it, refinance it or voluntarily surrender it, you may need to pay the lender to make up the difference between the car's value and the outstanding loan amount. If you're already struggling with your payments, this payment can make your situation much worse.

There may not be much you can do about being underwater on a car loan if you're already there. But here are a few ways you can avoid it:

  • Make a large down payment. Most cars depreciate over time—new cars tend to depreciate rapidly during the first year. If you don't make a down payment or put down just a little, your vehicle could depreciate faster than you're able to pay down the loan. Making a larger down payment can help prevent negative equity.
  • Opt for a shorter repayment term. A longer auto loan term can make monthly payments more affordable, but it can have an unintended consequence if you're not careful. Even if you put money down on your loan, a longer repayment term means you're paying down the loan more slowly, which could make it easier for depreciation to outpace your repayment.

Don't Forget About Your Credit Score

If your budget is tight and you can't afford your car payments, your primary concern may understandably be about your current situation and needs. But it's also important to think about the potential long-term ramifications of surrendering the car or having it repossessed.

As you consider your options for getting relief from your auto loan, make sure you understand how they can affect your credit and how you can minimize that impact. You can get a free copy of your credit report from all three major credit bureaus through AnnualCreditReport.com. You can also get your free credit report and score directly from Experian. Or consider using your Experian account to monitor your credit score, so you always know where you stand, and keep track of fluctuations, so you can address potential issues as they arise.