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Updated on Friday, March 26, 2021
We all make mistakes. Maybe you’re struggling to pay your bills, especially your car payment, and looking for a way to get out of that car loan. Or perhaps you’re doing better financially than when you purchased your car and it’s 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. Here’s what you should know:
- How do I know if I have a bad car loan?
- 6 ways to get out of a bad car loan
- Don’t forget about the long-term consequences
How do I know if I have a bad car loan?
A bad car loan is one that you can’t afford, or that costs you too much money in interest charges. If you’re struggling to make car payments or falling behind on your loan, you’re likely in a bad car loan.
What’s 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 you’re unemployed, however, the truck payments become a huge burden. You may even fall behind.
Another possibility is that you bought a car when you had 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 you’re in a bad car loan or one that no longer fits your needs, it’s time to start finding ways out of that loan.
6 ways to get out of a bad car loan
The best way to get out of a bad car loan will depend on your situation and goals. Are you trying to get a lower interest rate, get a lower monthly payment or not have car payments at all? If you don’t 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:
1. Refinance a car loan
If the problem is that you took out a loan with a high interest rate, either because your credit score was lower or because you didn’t shop around as well as you could have, you should probably refinance your car. Check the latest auto loan refinance rates to compare your rate with lenders’ best offers. Refinancing with a new lender, even if you only improve your rate by a little, means a fresh start with a healthy account.
What’s a good interest rate for a car loan?
“The interest rate you pay should not be higher than what you would pay on a credit card,” said Bruce McClary of the National Foundation for Credit Counseling (NFCC). “I would say any auto loan that carries an interest rate in the 20% range is something you would want to get out of quickly. In the teens, at the high end, you should consider refinancing.”
Check your credit score — scores of 660 or higher qualify for the lowest new auto loan rates, 6.64% or better, on average.
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 three-year loan, but the payments are too high. You might refinance with a four- or five-year loan, instead. Use an auto loan calculator to see how much you could save. Be aware that a longer term means you’ll pay more in interest over the life of the loan. We never recommend an 84-month auto loan.
Refinancing a car is almost always a better financial decision than getting a new car to get out of a car 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.
2. Renegotiate a car loan
If you just need help getting back on track, or need to make your payments more affordable, try talking to your current lender. It may offer a way to defer a payment or two, giving you some much-needed time to catch up.
Another way it may help is by extending the terms of your loan so your payments are lower. Remember, just like refinancing, when you delay or lengthen your loan, interest charges still accrue. The longer the term, the more total interest you will pay.
3. Pay off a car loan
If you want to get out your car loan without restructuring or refinancing it, look for a way to pay it off or pay it down. You may have savings you could tap, 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 IRS. For another, retirement funds are for retirement.
You could also sell investments or other vehicles to pay off your loan, or work extra hours. Here are ways to monetize a hobby. 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 don’t 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. You’ll 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.
4. Trade in a car to get rid of a bad loan
If you need a new car anyway, you could trade in your old car as a down payment on a new one. This way, you get out of your car loan and car. Dealers are motivated to sell you another car, so they’re almost certain to take your old car. They may even take it if you’re upside down or underwater on your current loan — if you owe more than it’s worth — 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.
Tips for trading in a car: Before you go to the dealership, check your credit score (if there is time, make improvements) and get an auto loan preapproval. The idea is to get a better rate this time around. Don’t just take financing at the dealership without comparison shopping first.
5. Surrender the car to the lender
If you’re in financial trouble and you can’t 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.
The problem with turning in your car is that it is a “voluntary repossession.” If you owe more on the car than the car is worth and you can’t pay the excess amount (which is likely if you can’t afford your payments), it may harm your credit history and score. You should also be prepared to keep making your car payments until the lender sells the car. Even then, you may be on the hook for the creditor’s expense of selling the car.
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. This means any car loan you get in the near future will likely carry a high-interest rate.
6. File for bankruptcy
If your finances have reached a point where you cannot pay your bills and you don’t see any other way out of debt, you may need to consider filing for bankruptcy. Bankruptcy may help you keep your car, which can be important if you need it to get to work and earn a living.
Filing for bankruptcy doesn’t get you out of a car loan, however. You must continue payments on your car loan to keep your car. However, filing for bankruptcy may give you relief from collection efforts by other creditors, making it easier for you to keep up with your car payments.
Alternatively, you can surrender your car in bankruptcy. You may be able to keep it until the bankruptcy is finalized.
Don’t forget about the long-term consequences
It’s tempting to think about short-term fixes to financial problems. And getting through this month and the next is important. Try to choose a path that lowers your interest expense and total debt, if possible. Avoid decisions that can harm your credit history. Your long-term financial health depends on taking a longer-term view as you decide on the best way to get out of your car loan.