A Guide to Refinancing a Used Car

Refinancing a used car can get you out of an upside-down debt faster. Upside-down debt occurs when the value of your car would not be high enough to cover the remaining expense on your loan if you defaulted today. Upside-down debts leave you with a higher debt-to-asset ratio. They also place you at risk of bankruptcy because you could not simply sell off the asset if your debt was nearing default. Unfortunately, these loans are very common with used cars.

Depreciation of Value

A car's value depreciates the moment it is driven off the lot. A car also experiences an exponential rate of depreciation. This means the car depreciates only slightly in the first 10,000 miles driven and then slightly more in the next 10,000 miles. Once a car has reached 50,000 miles, its value depreciates very rapidly. If you are not making large enough payments during this period of time, you will quickly see you are paying down a debt on an asset that is worth only a fraction of the total sum you still own. For this reason, used car loans should be shorter than new car loans.

Recourse Loans

Used car loans are also commonly subject to recourse responsibility. With a recourse loan, you are responsible for any loss in value if the car is repossessed and sold by the lender. Basically, the lender will seize a car if you default. The car will be liquidated to pay the remainder of the loan. The goal is to have the sum recovered from auction totally cover the remaining debt. Since a used car's value depreciates, if you are in an upside-down loan, you will still owe money after the car has been repossessed and sued. Default on the loan will not release you from this responsibility.

Refinancing Used Car Loan

Refinancing is a good idea if you would like to get out of an upside-down debt faster. You should consider refinancing to a higher monthly payment. When you do this, you can pay more toward the principal debt you owe each month than you are currently paying. Aim to pay at least as much as the estimated depreciation in the car's value during the same period of time. So, a borrower who drives 5,000 miles a month should pay a higher monthly debt than a borrower who drives 500 miles a month.

Settling Used Car Debt

If refinancing will not do enough to get you out of an upside-down debt, consider settling the loan. This is an option if you have a large sum of cash you can put toward the final balance of the loan. If this debt covers the principal you owe, even if it does not cover the total payoff quote, you may be able to cut a deal with the lender. In exchange for the immediate payment of the debt, the lender may be willing to forgive a portion of your interest payments. Electing to pay down debt when you receive a cash bonus or other financial gift is a great way to build your financial standing.