We all make mistakes. Maybe youâre struggling to pay your bills, especially your car loan, and are looking for a way to get out from under that burden. Or perhaps youâre doing better financially than when you purchased your car and itâs time to refinance into a better loan. No matter how you got into a bad car loan or why you want out of it, you always have options.Understanding those options is the first step to improving your financial situation. Hereâs what you should know:
If you have a bad car loan, you probably know it. A bad car loan is one that you canât afford, or that costs you too much money in interest expense every month. If you are struggling to make car payments or are falling behind on your loan, youâre likely in a bad car loan.
Whatâs important to realize is that circumstances change. You could have taken out a loan on a new pickup truck while you had a good job and could easily make the payments. When youâre unemployed, however, the truck payments become a huge burden. You may even fall behind.
Another possibility is that you could buy a car when you have a thin or damaged credit history, at a high interest rate. A year or two later, when you have a decent credit score, you could do a lot better. A good car loan when you bought the car is a bad car loan now.
If you think youâre in a bad car loan or one that no longer fits your needs, itâs time to start finding ways out of that loan.
The interest rate level you should consider to be âbadâ depends on your situation, primarily your credit score. âThe interest rate you pay should not be higher than what you would pay on a credit card,â said Bruce McClary, vice president of public relations and communications at the National Foundation for Credit Counseling (NFCC) in Washington, DC. âCheck your credit score and see where you are. Could you qualify for a lower interest rate loan? If you have a credit score in the 700s or 800s, youâll get a good loan. If itâs in the 500s or 600s, youâll probably still have to pay a higher interest rate.â
Generally speaking, the higher the interest rate, the more important it is to try to find another solution. âI would say any auto loan that carries an interest rate in the 20% range is something you would want to get out of quickly,â said McClary. âIn the teens, in the high end, you should consider refinancing.â
Before you decide how you should get out of a bad car loan, you should decide exactly what you hope to accomplish by doing so. Are you trying to get a lower interest rate, keep your car or not have car payments at all? If you donât set clear goals, you could get out of one bad loan only to make your financial situation worse.
Once you know what you want to achieve, you can decide which of these options is best for you:
If your only car problem is that you took out a loan with a too-high interest rate, either because your credit score was lower or because you didnât shop around as well as you could have, you should probably refinance your car. In fact, if you have a car loan, it pays to occasionally check that you are still getting the best deal possible on your car loan.
Refinancing with a new lender can help your credit history if you have missed payments on your car loan. âYou can get creative, refinancing the amount you owe and flipping it into a new loan,â said McClary. âThen, youâre starting with an account that is healthy.â Bear in mind that if you have missed payments, your current lender has probably already reported negative information to the credit bureaus. That information will stay on your credit history for up to seven years, even after you close the account.
You could also refinance your car loan if you want to change the length of the loan. For example, say you originally took out a 3-year loan, but the payments are too high. You might refinance with a 4- or 5-year loan, instead.
Refinancing a car is almost always a better financial decision than getting a new car to get out of a loan. You generally pay a few fees to refinance, but you avoid paying sales tax on a new car, and you avoid the temptation to buy a more expensive car, just to get out of a bad loan.
Be sure to shop around for a car loan refinance. You can start your search at your local bank or credit union, or online at MagnifyMoney. Fill out an online form, and receive potential refinance auto loan offers from lenders at once, depending on your creditworthiness. Use the auto loan calculator to see how much a car loan should cost, and how much you can afford.
If you just need help getting back on track, or need to make your payments more affordable, you can talk to your current lender. They may offer temporary hardship forbearance in certain circumstances, which means they can allow you a little more time to catch up.
Another way they may help is by extending the terms of your loan so your payments are lower. Be aware that the longer the term, the more total interest you will pay before your loan is paid off.
If you want to keep your car, look for a way to pay off or pay down your car loan. You may have savings you could use, if you can do so without jeopardizing your emergency fund and other goals.
Avoid taking money out of your retirement account. For one thing, you could owe a hefty penalty and taxes to the Internal Revenue Service. For another, retirement funds are for retirement.
You could also sell investments or other vehicles to pay off your loan, or work extra hours. Even if all you can do is make extra payments on your principal every month, you will pay off your car loan more quickly, and save a significant amount of interest expense.
If you donât want to keep your car; for example, if your household has two cars and can get along with one, you can sell your car to pay off the loan. Youâll get the best price if you sell your car yourself. Be aware that you need to gain enough from the sale to pay off the loan, or come up with the difference yourself.
If you need a new car anyway, you could trade in your old car as a down payment on a new one. The advantage of getting out of your car loan and car ownership, this way is that itâs easy. The dealership is motivated to sell you another car, so theyâre almost certain to take your old car. They may even take it if youâre underwater on your current loan â if you owe more than itâs worth â and roll the excess amount you owe into your new loan.
Trading in your car can be a good idea if you are hesitant to try and sell your car yourself, and you need a more reliable or different car.
It is not a good idea for people who might use a bad car loan as an excuse to trade up to a more expensive car that strains their budget and prevents them from ever paying off a car or reaching other financial goals.
If you trade in your car, make sure you get the best loan you can get. Check your credit score before you go car shopping, and make any improvements to your score before you shop for a loan. Donât just take financing at the dealership without comparison shopping the loans first.
If youâre in financial trouble and you canât keep up your car payments, one option is to give up your car. You can drive your car to the lender, or wait for them to come and get it.
Either of these options should only be a last resort. âYou can turn in the car,â said McClary. âTheyâre holding it as collateral. You can give them the keys and say, âHere. I can no longer afford it.ââ
The problem with turning in your car is that it is a âvoluntary repossession.â If you owe more on the car than the car is worth and you canât pay the excess amount (which is likely if you canât afford your payments), it may harm your credit history and score. You should also be prepared to keep making your car payments until they sell the car, if possible. âYou need to talk to someone immediately about clearing it,â said McClary. âYour credit wonât get any better unless you continue to make payments until they sell the car.â
Whether you turn in your car voluntarily, or you miss payments and they tow it out of your driveway, the repossession will be reported on your credit report.
The lender can sue you for the deficiency, or the difference between the amount you owe and the amount the car is worth, less the expenses of selling the car. So itâs possible you can lose or turn in your car, and still have car payments. And now your credit report is damaged, so any car loan you get will likely carry a high interest rate.
If your finances have reached a point where you cannot pay your bills and you donât see any other way out of debt, you may need to consider bankruptcy.Chapter 7 or Chapter 13 bankruptcy can actually help you keep your car, which can be important if you need it to get to work and earn a living.
Filing for bankruptcy doesnât get you out of a car loan, however. You must continue payments on your car loan to keep your car in bankruptcy. However, filing for bankruptcy can give you relief from collection efforts by other creditors, making it easier for you to keep up with your car payments.
If you are considering bankruptcy and you want to keep your car and car loan, you must indicate to the court that you want to âreaffirmâ the debt. By reaffirming, you promise to pay your car loan as if you had not filed for bankruptcy, in exchange for keeping the car. You must show that you can afford to make the payments and that the vehicle is necessary. Your ability to keep your car may depend on your equity in it, and your state law. If you reaffirm the debt, but fail to make the payments, you can still lose the car.
Alternatively, you can surrender your car in bankruptcy. In a Chapter 7 bankruptcy, this wipes out your debt. You may be able to keep your car until the bankruptcy is finalized.
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