Posted on 04/05/2005 12:22:02 PM PDT by ex-Texan
Consumers often purchase a new vehicle while still owing thousands of dollars on their old one, which they use as a trade-in
NEW YORK -- A growing number of new car buyers are finding they owe more on their existing car loans than the vehicles are worth as trade-ins.
The phenomenon, known as being "upside down" on a loan, is the result of a confluence of changes in the ways Americans buy and finance their vehicles.
To begin with, the prices of new cars and trucks have been held down as manufacturers offer incentives and rebates to lure purchasers. As new car prices flatten, so do resale values. Buyers, meanwhile, are choosing increasingly longer-term loans, sometimes extended over 84 months, to reduce monthly payments.
The result is that a consumer who trades in a car that isn't fully paid for can end up wrapping the loan hangover into the financing for a new car, greatly increasing the cost. Or, if a car is destroyed in an accident before it's paid off, the insurance settlement may not fully cover the outstanding loan.
The consumers' upside down amounts are substantial, experts say.
"More than a quarter of buyers are upside down when they come in, and the average is nearly $3,800," said Bob Kurilko, a vice president with Edmunds. com Inc., an auto information publishing company based in Santa Monica, Calif.
This loan overhang has implications for both trade-ins and insurance recovery, he pointed out.
Here's the math: Say a consumer buys a $25,000 car and begins making payments of about $500 a month, based on a 6 percent interest rate. A tree blows over in a storm, flattening the vehicle. The insurance company agrees to pay, but values the car at $22,000; the consumer is still on the hook to the finance company for $3,000 more, which must be paid out of pocket.
Scott Jones, 43, a New York freelance photographer, said he was aware of the risk of becoming upside down on a car loan when he went shopping for a new vehicle last spring.
"I read about it on some of the Web sites, and I tried to shop carefully to avoid that trap," Jones said. His strategy, he said, was "to buy a reliable car and pay it off as soon as possible."
Jones' choice of a vehicle was a Honda Odyssey minivan, which he believes will hold its value better than some other vehicles. He made a cash down payment to reduce the size of his loan, and then financed the balance over six years, though he said he may try to pay it off earlier than that.
"I figure I'll be driving it for at least 10 years -- long after the loan is finished," Jones said.
Brian Reed, a vice president at Capital One Auto Finance, based in Plano, Texas, said a major contributor to the problem is that consumers have sought longer loans to hold down their monthly payments.
"In the late 1970s and early '80s, most loans were for 36 months," Reed said. "Now, the average term is about 58 months, and some lenders go as long as 72 months or 84 months."
Consumers with long-term loans who trade their cars frequently will have built up less equity and be more likely to be upside down, he pointed out.
The best strategy, Reed said, is "to try to match the term of the loan to the time you intend to keep the vehicle."
Rob Gentile, director of automotive information products for Consumer Reports, based in Yonkers, N.Y., said consumers who know they're upside down on loans often don't bargain well for new cars because they're distracted by how that unpaid loan is going to be handled.
"Consumers should settle on the price (of a new car) before anything else," Gentile said.
Gentile also recommends consumers finish paying down a loan before they trade a vehicle, especially if it's been a good, reliable car.
"If you roll what you owe into the new car loan, you're financing the old car at the same time you're financing the new car," he pointed out. "That will cost more in interest -- and your monthly payment will have gone up, too."
well, look at people you know. do they have mortgages, credit card debt galore, home equity loans used to fund purchases of consumer goods, car leases and long term car loans. do you know people who borrow via credit cards for clothes, vacations. people with college debts.
are you telling me you don't know any people like this? we must be living in different countries.
Best $1000 I ever spent. :)
There's one major flaw in your suggestion. If you buy a $20,000 car and it gets stolen a week after you bought it, you're out $20,000.
What I would recommend instead is that you get a comprehensive insure policy and put aside some cash ($2,000 or so) to serve as a high deductible, thereby reducing your insurance cost.
This is how you back up your theory? People I know? People you know?
You can do better than that, can't you?
Lease. Take the tax deduction. Repeat every three years.
Yes, especially when you can make more on that money in investments than you'll pay in interest on the loan/financing. The 2.8% I'm paying on my car financing (negotiated price before any mention of that, and put 1/3 of the car's value down so I don't end up upside down) is far exceeded by the rate of return I'm getting on investing my cash in the meantime.
A vehicle "depreciates" in the same way a Big Mac depreciates . . . it loses its value as you use it.
If you are like me and you keep your cars until they fall apart, it doesn't matter if a new vehicle loses 20% of its value as soon as you drive it off the lot, 40% of its value in the first year, or 100% of its value in the first 100 miles you drive it. If you keep it until it falls apart, there's an inherent expectation that it will be worthless by the time you are finished with it.
I did buy a NEW Toyota Echo. It gets 39 to 42mpg and thus is saving me a decent amount of money on gas.
there are plenty of articles in the financial press about the debt loads of americans. its hardly a secret. those people I know, they are part of that statistic.
Actually, if I was going to keep it for 10 years -- really though, what are the chances of that? -- I could certainly justify a new one.
FWIW, I drove my first (and last) new car for 13 years.
only self-incorporated people can deduct their car lease payments. that should be eliminated by the way, its a major abuse in the tax code. these people lease a car for personal use and get to write it off, while regular wage earners have to pay for it with after tax dollars.
When I see price tags on a vehicle reaching 50 and 60 thousand plus, I just scream out, AreYou Out Of YOur Mind? I can't believe people are going so far in to debt for a vehicle. I'm sorry, but my mind just can't grasp it. I drive the same vehicle for a min of 7 years. I never buy new. Why should I? This is just insane. The newest vehicle sitting in my yard right now is a 91 Prelude. Which I will probably start driving soon because of the price of gas. The vehicle sitting in my yard right now that will fetch us the most money is the 68 camaro. Go Figure.
Cars have gotten ridiculously expensive. I think a lot of it is the mandatory safety equipment that we are forced to buy, airbags, etc. I would gladly give up the airbag to pay less for the car. I think that should be my option to choose.
bump for later reading.
I drive a '94 with 125,000. What bothers me most is that a few of the clips holding the interior plastic trim have broken. Nothing is falling off, but it rattles a lot when I drive. Part of me likes my current payment ($0), part of me is ready for a new car.
You've got it backwards. It's the tax cosde that should be done away with, not the provisions that encourage entrepreneurial activity.
In the meantime, if you're in a position to lease, take advantage of what little grace the revenuers permit. I lease a much nicer car than I would ever consider buying. And, yes, I do use it for business -- extensively, actually.
Cars have gotten ridiculously expensive. I think a lot of it is the mandatory safety equipment that we are forced to buy, airbags, etc. I would gladly give up the airbag to pay less for the car. I think that should be my option to choose.
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You can thank our lawmakers and the UAW.
You hit it on the button. Cars are no different then the carpet in your house. The better you take care of it the longer your going to get to use it. Either way, when you're done with it, it is worth nothing.
Only way to go.
My husband is an electronics engineer by vocation and a grease monkey by avocation. We pay only for parts. He is a little leery of this new car and its electronics but it is nothing he couldn't reverse engineer if he really wanted. Since I don't maintain the cars, I don't pick them. He and his dad chose this newest one and I am satisfied he will be able to fix most of the problems even if he has to jury-rig some parts. That isn't hard for him since he does his own metal work and computer designs and can build HO-scale model trains from the ground up. If he believes he can maintain it, so do I.
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