If You're Selling a Car That's Underwater, Don't Make This Mistake

Car loans are a common way to purchase a vehicle, especially as car prices have been rising. The average auto loan balance in 2022 hit $22,612, which was a 7.7% increase from the year before.

Unfortunately, many people end up taking out car loans with long payoff times -- and drivers often put very little money down when they purchase. This can mean that many people end up underwater. That's what it's called when you owe more on the car than you could sell it for. For example, if you owe $20,000 on a car with a fair market value of $15,000, then you are underwater.

If you find yourself in this situation, it's important to understand the reality of what being underwater means for you. Unfortunately, many people don't realize the impact of this state of affairs and they end up making a financial mistake.

Don't make this error if you're underwater

If you are underwater on your vehicle and you decide you no longer want to own the car for some reason -- whether because you are tired of big car payments or you don't need it any more -- you may assume that you can just sell the car and keep paying on your car loan until you've covered the remaining balance.

For example, in the above scenario, you may believe you could just sell the car for the $15,000 that it is worth, pay down most of your big car loan balance, and simply keep making payments on the outstanding $5,000 loan amount that is due after your car is sold. Sure, you would be paying debt on a car you don't have any more -- but you would have a much smaller loan balance to worry about.

Unfortunately, this is not the reality. Typically, in order to sell the car, you would have to pay off the existing car loan in full before you could move forward. So, you would have to find some solution to dealing with the $5,000 unpaid balance and that solution can't be to sell the car and worry about it later.

This could be a huge problem if you really do need to sell, but can't do so because you don't have $5,000 (or whatever amount) to pay off the difference between what the car is worth and what you owe.

What should you do if you're underwater on a car loan?

Since you can't sell a car and keep making payments on its loan when you're underwater, you will need to explore other options if you need to offload a vehicle you owe a lot of money on.

The best option would be to try to save money to pay off the extra you owe on the car above its fair market value. You could make extra payments on your car loan each month to pay your loan balance down faster so you can get out of being underwater. Or you could make a large lump-sum payment for the difference between what you owe and what you get for the car when you sell it.

If you don't have the cash to do that, you could try to borrow using a personal loan and use the proceeds from that loan to pay the difference between the car's worth and its loan balance. Or, if you are getting a new car, you could try to borrow enough on that car loan to repay your current vehicle debt and fund your new vehicle purchase -- but this just increases your chances of ending up underwater again, since you'd be taking out a larger loan for the new car

None of these are great options, but you'll need to decide which ones make sense for you -- unless you can just hold onto the car for a while longer and try to pay down your loan quickly. This way, you won't keep losing ground as the car's value decreases faster than your loan balance falls.