Options for When You Can No Longer Afford Your Car

In practical terms, a car is a source of transportation, but when it comes to buying a car, most people go above and beyond these practical needs. Many people end up paying a lot of money to get additional automobile luxuries such as DVD players, navigation systems, automatic everything, more power than they need and more. All of this is fine, as long as you can afford it. (For more see: The True Cost of Owning a Car.)

Experts say that you should be paying no more than 15% to 18% of your income for this "debt on wheels." This figure includes car payments, maintenance and car insurance. Anything above this means that you can't afford the car and it's wise to settle for something within your means. Since many people look at buying a car from the perspective of monthly commitments, the golden rule is to buy a car that you can pay off within 36 months. If you cannot afford the monthly payments that will allow you to pay it off in that short a period, it means you can't afford it. (Also check out 5 Ways to Buy a Used Car.)

When Life Throws a Curve Ball

What if you've already bought too much car and you now can't afford it? A layoff, demotion, divorce or any drastic downturn in your financial situation could mean you are stuck with a fancy car and are staring at repossession or a bad credit report. What should you do?

To start, you need to confront the situation. It may be very hard to accept the fact that you're short of money and can't afford your dream car. The earlier you make the decision to do something about the problem, the better. This way you will avoid compounding the problem.

4 Ways to Fix Your Car Dilemma

Once you are ready to tackle the issue, there are several options you can try in order to solve it.

1. Go back to your car dealer. The first option is to talk to your dealer about the option of trading in your car for a less expensive one. Most dealers want you to stay with the brand and will have options to help you out. Hyundai, for example, has a very friendly return policy.

However, this may not work because the value of a new car depreciates really fast. After just a few months of owning the car, you may owe more than its current value. Imagine your car value has depreciated to $20,000 but you still owe $25,000 on it. Even if your dealer agrees to trade your car for a less expensive one, you will have to pay the difference of $5,000.

SEE: Buying A Car: The Worst Investment?

2. Refinance the car loan. The second option is to look at refinancing your car loan. You may try to extend the  loan or look for refinancing at a lower rate. Some finance companies may offer a higher interest rate instead, but they will extend the loan period substantially. This is not the smartest financial move, but it could bring down your monthly payments and tide you over.

3. Sell your car. Another good option is to sell your car and pay off the loan. If the car is now worth less than you owe, consider taking a personal loan to cover the difference when you pay back the lender. Financing the difference with a credit card is a bad idea. Once you are free from the loan, you can make a wiser choice – buy a used car, use public transportation or get a bike.

4. Find someone to assume your payments. You also have the option to find someone who will be ready to take the car and the loan from you. You can advertise in market places such as Craigslist and eBay Motors to find potential buyers.

And a 5th, If You Lease

If you've leased the car, it is a very different situation because you don't own the car and can't sell it. You can return the vehicle to the dealer, but you will still owe the balance remaining on the lease. You also lose the upfront money paid for the car and pay an additional recapture fee. A better option is to find someone who will be willing to take over the balance of payments for your car. This is called a lease transfer and most leasing companies allow you to do that. The Best Way to Get Out of Your Car Lease explains the process in more detail.

The Bottom Line

Like all deep-in-debt positions, it is important to take a hard look at your lack of financial well-being and seek help to get back on track. All stakeholders in a car purchase – the dealer, the lender and you – can minimize damage if you diagnose the condition quickly and act on it swiftly.