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Understanding Auto Loan Settlements

What Is an Auto Loan Settlement?
Austin Kilham
Austin KilhamUpdated April 7, 2023
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If you encounter financial difficulties and you’re unable to repay your auto loan, there are ways to get relief from the debt you owe. For instance, you could pursue an auto loan settlement.But before you go this route, there are some downsides to an auto finance settlement that are important to be aware of. For instance, a car loan settlement might have a negative impact on your credit score. Weighing the advantages and disadvantages of auto loan settlement is crucial. 

What Is an Auto Loan Settlement?

An auto loan settlement is an agreement between you and your creditor that allows you to pay off your auto loan debt for less than the remaining amount you owe. Can you settle on a car loan? Yes. A settlement may become an option when you can’t make regular loan payments. 

How Do Auto Loan Settlements Work?

When it becomes clear that you will be unable to pay off your auto loan in full, your lender or a collections agency may come to you with an offer to settle. If you accept the offer and pay off the agreed-upon settlement amount, your debt is settled and you no longer owe any money on the loan. Creditors and collections agencies may prefer car loan settlement to other options that might be much more time consuming and costly, such as car repossession

Can You Negotiate a Car Loan Settlement?

If you’re looking to get out of your car loan, you may be able to negotiate your car loan settlement amount. For instance, you could draw up a letter that states how much you’re able to pay and outline a payment plan that works for you and take it to the lender or collections agency. They may accept your plan or give you a counteroffer. Be sure all the settlement negotiations are in writing so you have documentation of them. When a settlement is reached, get the terms of the agreement in writing as well before you send any money to collections or your lender. 

Auto Loan Settlement vs Repossession 

An auto finance settlement is different from a repossession. When you default on your auto loan, your lender may seize or repossess your vehicle and then sell it to recoup their losses. Or you may even choose voluntary repossession of the car so the lender can sell it.If there’s a difference between the amount received from the sale of the car and the amount of money left on the loan, that’s what’s known as a deficiency balance. You’re responsible for paying it off. If you’re unable to pay the deficiency balance, you may be able to reach a settlement on the remaining debt with the lender.

Things to Consider Before Settling Your Car Loan

Before you choose to settle your auto loan, there are some important factors to think carefully about. These include: 

Impact on Your Credit Score

An auto finance settlement will have a negative impact on your credit score. A settled account stays on your credit report for seven years, and creditors will see that you were unable to pay off your loan. A low credit score can make it more difficult and expensive to secure credit in the future. 

You May Avoid Default

Despite the impact on your credit score, settling your loan may sometimes be your best option. Creditors look more favorably on settling a debt than defaulting on a loan. In certain cases, settling your loan might put you on a faster track to rebuilding your credit over time. 

You Could Owe Taxes

When a lender agrees to a debt settlement that’s less than the full amount of your loan, you might end up owing money in taxes. The IRS treats this kind of forgiven debt as income. As such, it’s taxed at your normal income tax rate.If your lender forgives more than $600 in loan principal, they are required to send you an IRS Form 1099-C. Even if you don’t receive a 1099-C from the lender, you’re still obligated to report any forgiven debt amount as income when you file your taxes. 

Alternatives to Auto Loan Settlement

Because of the negative impact on your credit score and financial future, an auto finance settlement is generally an option you’ll want to pursue as a last resort. Consider these four alternatives first.

Pay Off the Loan

If possible, the best option is to pay off your loan in full. In doing so, you’ll build your credit, making it easier to secure loans in the future. Perhaps you could borrow money from a family member, for instance, to make the full auto loan repayment.

Modify the Loan

As soon as you see that your loan payments are becoming unmanageable, contact your lender and ask if they can modify the loan to make it easier to pay. The lender may agree to defer your payments for a short time until you can get back on your feet. Or, they might lower your interest rate, extend your loan term, or change the due date of your payments. See what you can work out.

Sell Your Car

If you can no longer afford the loan payments, and public transportation is available, you could sell the car and use the proceeds to pay off your loan. 

Refinance Your Loan

Refinancing a vehicle loan allows you to take out a new loan — preferably with a lower interest rate or more manageable terms — and pay off your old loan. A lower interest rate on the new loan will make your monthly payments smaller and reduce the amount you pay over the life of the loan. Extending your loan term may also lower your monthly payments, making them easier on your budget. But be aware that with a longer loan term, you may end up paying more in interest over the life of the loan. Once your loan application is approved and when the car loan is finalized, the new terms or rates will kick in. 

The Takeaway

If you can no longer afford to repay your auto loan, there are several options to explore before you consider an auto loan settlement. For instance, modifying or refinancing your loan could help you pay what you owe, while also protecting your credit score and financial future. If you’re exploring auto loan refinancing, Lantern can help. By filling out one simple form, you’ll get offers from multiple lenders in our network in just minutes. Then you can easily compare the rates and terms to find the best option for your situation.

Frequently Asked Questions

Can you do a settlement on a car loan?
Does settling an auto loan affect your credit score?
How long does a car finance settlement take?
Photo credit: iStock/Jose carlos Cerdeno

About the Author

Austin Kilham

Austin Kilham

Austin Kilham is a writer and journalist based in Los Angeles. He focuses on personal finance, retirement, business, and health care with an eye toward helping others understand complex topics.
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