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For many people, a car provides necessary transportation for work, school or other everyday needs. But with an average auto loan balance of $22,612, owning a car can be expensive.
If you're struggling to keep up with your payments, you may consider selling the vehicle, working with your current lender, refinancing your car loan or voluntarily surrendering the car to your lender. Before you decide which path to choose, 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, which acts as collateral for the loan. You'll make equal monthly payments for the life of the loan and can be granted a loan term of anywhere from 12 to 84 months.
Your loan's interest rate is based on a variety of factors, including your credit score, income, repayment term and the vehicle you buy. If you fail to repay your loan as agreed, the lender can repossess the vehicle to recoup the remaining loan amount.
You can get a car loan from a number of places, including banks, credit unions and vehicle manufacturers. 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 Payments
During the financing process, it's crucial to ensure that a new car payment fits in your budget without requiring you to sacrifice other financial goals or necessities. But if your circumstances have changed or you misjudged your ability to pay your loan, here are some potential steps you can take to get rid of the car payment.
1. 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.
2. Negotiate With Your Lender
If you don't want to get rid of your car, 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.
3. Refinance Your Auto Loan
Refinancing your car loan involves replacing your current loan with a new one. Depending on your situation, you may be able to qualify for a lower interest rate or a longer repayment term on the new loan, both of which can help lower your monthly payment.
But while a lower monthly payment is the primary objective, also consider how much more you'll pay in interest over the life of the new loan compared to your current loan. Also, check for a prepayment penalty on your current loan to understand all the potential costs.
Before you apply for refinancing, you'll want to shop around for the best interest rate to ensure the biggest savings in your finance payments.
4. Voluntarily Surrender the Car
If you've defaulted on your auto loan, the lender may choose to repossess the car. The process isn't pleasant, and it can seriously damage your credit score. If you want to avoid repossession and 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.
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.
Options With a Minimal Impact
- Selling the car: If you sell your car and use the proceeds to pay off the loan in full, it's common to experience a temporary drop in your credit score. Additionally, 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. In both cases, however, there's generally no long-term damage.
- 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 on a longer-term modified repayment plan, the lender may report that you're no longer making payments as originally agreed, which could impact your score and how future lenders view you.
Options With a Large Impact
- 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 and when the new account is opened. Credit inquiries typically won't impact your credit score much, but adding a new account could affect your average age of accounts, which is a credit scoring factor.
- Voluntarily surrendering the vehicle: By the time you're considering a voluntary surrender, you've likely already missed some payments, which can considerably lower your credit score. You may also have been threatened with repossession. While giving up the car may look better to lenders reviewing your credit report in the future, it still has a significant negative impact on your credit profile.
How to Avoid Going Upside Down on a Car Loan
Being upside down on a car loan, also called being underwater or having negative equity, occurs when you owe more on your loan than the car is worth.
If you're upside down on your car loan, selling the car, refinancing the loan or voluntarily surrendering the vehicle can get more complicated. In particular, 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 extra 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.
- Trade it in. While it's not ideal, trading in a car with negative equity can be a better alternative to repossession or voluntary surrender. Instead of requiring you to pay off the deficiency to the original lender, the dealer may be able to roll it into the new loan. The problem is that you'll likely be upside down on the new car immediately. Also, depending on how much the deficiency balance is, you might exceed lenders' loan limits, which may go up to 130% of the value of the car you're buying.
Understand the Impact of Your Decision on 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 monitor your credit for free with Experian to understand how your actions impact your credit and take action when needed to avoid significant damage to your score.