Voluntary repossession of a vehicle is a strategy that has become more common recently as the price of vehicles continues to rise and some people have trouble making their car loan payments. While there are no detailed statistics regarding this practice, a recent article in The Wall Street Journal reported that it is becoming more prevalent.
What is Voluntary Repossession?
Voluntary repossession of a car occurs when a car owner who can no longer afford to make payments tells the lender to take possession of the vehicle. It often happens when car owners are trying to replace their vehicle with another one that’s less expensive.
Unfortunately, car dealerships sometimes are unable to accept the owner’s vehicle on a trade-in. In this scenario, some dealerships are telling owners that the best solution is to stop making car payments and have the vehicle repossessed, according to The Wall Street Journal article. This practice is sometimes referred to in the industry as “kicking the trade.”
The dealership then sells the car owner another car, which the customer usually buys on credit, just like the first vehicle. As a result, the customer walks out of the dealership owning two cars — and owing money on two car loans — until his or her original car is repossessed.
Is Voluntary Repossession Smart?
So is voluntary repossession of a vehicle a smart strategy? In general, the answer is no.
One of the biggest potential drawbacks of voluntary repossession is the fact that borrowers may still be responsible for a portion of their outstanding debt on the vehicle after it’s repossessed. Lenders try to sell vehicles they’ve repossessed but they aren’t always able to sell them for enough money to cover the outstanding loan balance. When this occurs, the borrower will be liable for repaying the lender the difference plus any associated fees.
For example, let’s say that Betty did a voluntary repossession of her Honda Accord on which she still owed $15,000 when she bought a less expensive Honda Civic. However, her lender was only able to sell the Accord for $10,000. In this scenario, Betty will be responsible for repaying $5,000 to the lender.
Remember that Betty also took out another car loan to finance the Civic. So in addition to repaying her new loan, Betty also has to repay money to the original lender for a car that she no longer owns.
Impact on Your Credit
Another potential drawback to voluntary repossession is damaged credit. From the credit reporting bureaus’ perspective, there’s little difference between an involuntary and voluntary repossession of a vehicle — either type of repossession will hurt your credit score. And this, in turn, could affect your ability to buy other items on credit in the future.
Instead of voluntary repossession, a better strategy might be to talk to your lender about refinancing your existing car loan. By renegotiating to obtain a lower interest rate or longer repayment period, you might be able to lower your monthly payment, which could make your existing car loan more affordable.
Another possible option is to sell your vehicle instead of voluntarily having it repossessed. Then you can use the proceeds to pay off your car loan. This strategy works best if your vehicle is worth more than your remaining loan balance — otherwise, you’ll need to come up with enough cash from somewhere else to pay off the rest of the loan.
Unintended Consequences May Result
You should think carefully before agreeing to voluntary repossession of a vehicle. This strategy may lead to unintended consequences that can be damaging to your personal finances.