How to Get Out of a Car Loan Explained
Life changes quickly and there are many reasons you might want to get out of your current car loan. Maybe you need a new car because your family is growing or you’d like to downsize to a vehicle that’s more fuel efficient. It’s also not uncommon to become overwhelmed with your loan payments because of an unexpected financial burden — like losing your job or having to pay for home repairs after an emergency.
What does it mean to be upside down on a car loan?
If the amount of money you owe on a car is higher than the value of the car itself, you’re dealing with negative equity or an “upside down” car loan. If you choose to sell your car in this situation, you won’t make enough money to pay off the remainder of your loan.
Getting upside down on a car loan can happen for a few different reasons. For example, if you bought your car with a small down payment or no down payment, you owe nearly the entire amount of the vehicle. Once you drive it home, the car is worth less than the loan because of depreciation. You can also get into negative equity if you overpay for a vehicle or opt for a bunch of add-ons that don’t increase the value of your car.
Being upside down isn’t always a bad thing because the value of your car and the amount on your loan will balance out over time. But if you need to sell your car when you’re upside down, you’ll lose money.
Have negative equity? Check out our blog post on what to with a negative equity car loan.
CAN YOU GET OUT OF A CAR LOAN WITHOUT RUINING YOUR CREDIT?
If you’re wondering if you can get out of a car loan without destroying your credit, the short answer is yes, you can. The main thing is ensuring the amount you owe on the loan is paid as agreed. Keep reading to find out some creative ways to get out of your car loan without affecting your credit rating or your finances.
CREDIT SCORE & BUYING CARS EXPLAINED
Your credit report is a major factor considered by lenders when buying a car. The better your credit score and history, the more likely you’ll qualify for good financing rates and terms when it comes time to get an auto loan. Below, we’ve further broken down what a credit score is and why good credit is so important when financing a car:
What Is A Credit Score?
Your credit score is an important piece of your financial footprint. It allows you to buy a new vehicle, get approved for a mortgage, and make purchases on a credit card. If your credit score is high, you’ll have access to more financial opportunities with better rates. Here in Canada, credit scores range from 300 to 900, with 900 being a perfect score. If you have a score between 780 and 900, your score is considered excellent.
If your score is between 700 and 780, it’s still considered a strong score and you will most likely be approved for financing at good rates. When you start hitting 625 and below, your score is considered on the low side and you will probably start finding it difficult to qualify for any borrowing or financing options.
Get a complimentary and secure credit report so you know where your credit stands with our Secure Credit Check.
Why Good Credit Is Needed To Finance A Car
Potential lenders prefer to see an established credit history, as it proves to them that you will be responsible with new credit—like an auto loan. They will be looking at things such as how long it’s been since you first obtained credit, how long you’ve had each account and how actively you’re using your current credit. In short, a better credit history means better interest rates when borrowing and bad credit (or lack of credit) will make it much harder to borrow in general.
HOW CAR LOAN DEBT AFFECTS YOUR CREDIT SCORE
Missed Car Loan Payments
As a vehicle owner, making your monthly car payments is crucial. By signing auto loan papers, you’re promising to make the payments on time every month. Of course, things can happen in life and you may face a situation where you aren’t able to make your loan payments. As tempting as this may be, it’s important to know how defaulting on your loan will affect your credit score.
Missed or defaulted loan payments can cause your credit score to drop over 100 points. That is a lot of points! Lenders can also repossess the vehicle and you will still be responsible for paying the additional fees and interest. If the car ends up being auctioned off for less than you still owe on the loan, you could face a remaining balance to pay.
Paying Off Car Loan Debt
You might wonder how paying off your car loan debt will affect your credit score. The surprising answer is that paying it off can affect your credit score negatively. Your score is improved when you make consistent and on-time loan payments. So, when you pay off your debt early, you are taking away that benefit. If you’re trying to rebuild your credit, it’s important to carefully think about the decision of getting out of your loan. Yes, you will have the advantage of deleting a monthly expense, but the drawback is taking away the benefit of an ongoing payment history.
HOW VOLUNTARY SURRENDERS AFFECT YOUR CREDIT SCORE
Voluntary repossession of your vehicle should always be a last resort decision. Doing so can extremely damage your credit score because it means you weren’t able to fulfill your side of the loan agreement. Although a voluntary repossession will still affect your credit score negatively and could make it harder to get future lending, it still might be a less damaging option than involuntary repossession. This is because it indicates you were proactive and willing to work with your lender to try and resolve your situation.
How to get out of your car loan
Here is a list of tips on how to get out of a car loan with your credit rating and your finances intact:
- Figure out your car’s current market value.
- Sell your car.
- Transfer your car loan.
- Refinance your car loan.
- Voluntarily give your car to your lender.
- Talk to your lender.
Figure out your car’s current market value
Cars lose value very quickly. Unlike houses, which can get more valuable over time, vehicles are an asset that wears out over time and as they get older they are more costly to maintain. In fact, new cars depreciate by several thousand dollars as soon as they’re driven off the dealership’s lot.
It’s important to figure out how much your car is currently worth because it can affect how you should go about getting out of your loan. Do a quick Google search and find a car value calculator that takes your vehicle’s make, model, year, and number of kilometers into account. Check out online classifieds and see what used cars with similar features are selling for. Once you have a dollar figure, you can find out if it makes sense to sell your car to pay off your loan.
Sell your car
If your car is worth more than the remainder of your debt, you can sell your car and use the profits to close out the loan. You’ll be able to pay off your debt in full and your credit rating will stay the same. It’s a good idea to let your lender know if you’re planning on selling your car as they might have specific requirements for closing out your loan.
Transfer your car loan
Another option is to transfer your loan to the person who is buying your car. If you find someone who is willing to take on your debt — maybe a friend or family member — you might be able to work out a new contract under their name with your lender. The new loan owner will have to meet certain criteria set out by the lender, such as having a good credit rating and proper insurance coverage.
Banks and credit unions have stricter regulations and can be more hesitant to accept loan transfers. If you are able to transfer, make sure all of the required documents are signed by the new owner, otherwise you could be on the hook if they default on the loan.
Unfortunately, if your car has negative equity, option #2 and #3 might not be available to you.
Refinance your car loan
If you aren’t able to sell your car and are struggling to make your monthly payments you can talk to your lender about refinancing or renegotiating your loan. This is usually the easiest solution for both parties because your lender will avoid having to pay to repossess your car if you default, and you’ll be able to get a better rate on your loan without ruining your credit.
Refinancing means getting a new loan to pay off an existing one, while refinancing means changing the terms on your current loan. Depending on your priorities, you can ask for a loan with lower monthly payments, lump sum payment options, lower interest rates or a different loan term. If you had less than stellar credit when you purchased your car but it has since improved, you will probably be able to get a more competitive interest rate.
Bear in mind that it’s not a good idea to refinance if your current loan has a repayment penalty, which means you’ll be charged a fee for paying off your loan early.
Voluntarily give your car to your lender
Voluntary repossession should be a last resort because it can significantly damage your credit rating. If you can’t pay off your loan balance by selling your vehicle or don’t qualify for refinancing, you can voluntarily give your car to your lender if you’re worried about defaulting on your loan. The lender will sell it at auction and if it can’t get enough to pay off the loan, you will have to cover the difference.
By having your car voluntarily repossessed, you avoid having your vehicle seized by a collection agency, but you will get a mark on your credit rating and will have a hard time getting a loan in the future.
Talk to your lender
If you’re worried about defaulting, make sure you talk to your lender first about your situation. It may be able to work out alternative options such as lower payments to pay off your remaining balance or voluntary repossession (see above). Communicating with your lender will create an open dialogue, which could bode better for you than avoiding the situation altogether.
THE BOTTOM LINE
At Birchwood Credit, our in-house auto financing specialists understand that all financial and credit circumstances are different and will work to find you the car loan that suits you best. Get in touch today to learn about our flexible, hassle-free financing options. Get started here.
