For Many U.S. Car Buyers, the World is 'Upside Down'

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.

"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."

Yes, lots of people have lots of debt. Doesn't change the fact that household net worth is at an all time high. If you want to prove that people younger than baby boomers have a negative net worth, than prove it. Stop talking about people you know. Put some facts on the table, for once.

I don't know whether OceanView found facts to support his argument or not, but he is actually correct in his assertions. The economy is essentially financed to a great degree by consumer debt. In fact it has been stated over and over again ad infinitum in government, corporate and media reports. And it is so common that, to use OceanView's posts, most people only need to look at either their spending habits, or their neighbors.

According to the IRS 85% of those reaching age 65 do not have $200 in the bank and that 87% retire on less than $250 per week for life. And to make matters worse due to the credit culture run amok there is an increased trend of men worth more at age 18 than at age 65.

And I am not just talking about the personal scene but also corporate. The Financial Times had an interesting article about 2 weeks ago (March 13) where they were showing how fears of a credit bust had led bankruptcy advisers to hire more staff. The credit boom that has been going on for the last couple of years led to many speculative-grade firms to leverage and debt finance themselves up the wazoo.

Going back to the personal credit area, allow me to say one thing. Credit is not bad. IF correctly applied it can be a great boon. The problem is many people who dabble with it do not handle it prudently. When i was doing my undergrad i would see kids applying for bankruptcy protection (i know of two who killed themselves). It is really ridiculous how much people spend beyond their means, and it is ok while everything is fine but if a shock (ANY shock) comes up the possibility of an instant fold is heightened. Eg let's say either the husband or the wife is laid of! Most households with mortgages (according to certain reports 90% of home owners with a mortgage) are leveraged to the hilt! One spouse losing their job usually means foreclosure. It is that simple.

By the way, you stated that 'household net worth is at an all time high.' You are 100% correct. However, in the coming year this will really bite many people as they find themselves squeezed like heck. People took out crazy loans during the refi boom. Including some brave souls who went the 'interest only' route, enabling them to 'afford' houses that they simply wouldn't have been able to before. Not to mention the even braver souls who went down the ARM loan route! Those loan instruments were never meant to be used by any Tom Dick and Harry, but in 2003 everyone and their aunt were jumping on them. I know ....I had just graduated from my undergrad in 2002 and in 2003 i had been made 2nd in charge of financial hedging for acquired loans for a certain banking institution. Out of curiousity i would look at the loans been sold institutionwise, and it was obvious that most of the peope opting for ARMS shouldn't have even been thinking about them.

Barron's recently published a striking chart, showing Household Surplus (more income than outgo) compared with Household Deficit. Throughout the 1960s, '70s, '80s, and '90s, households showed a surplus of varying degrees. It wasn't until 1999 — for the first time in about 50 years — that U.S. households started spending more than they took in. What started as a small deficit of about $50 billion among households quickly spiked to a deficit of more than $350 billion in the second quarter of this year.

About a month ago, the New York Times examined how the use of credit has taken off dramatically in the United States since 1990. While the number of people holding charge cards grew about 75 percent— from 82 million in 1990 to 144 million in 2003— the amount they charged during that period grew by a much larger percentage: approximately 350 percent, from $338 billion to $1.5 trillion.

Since the number of chargers is growing at a slower rate than the amounts being charged, you can guess what that means. Yes, the monthly revolving balances have been growing by leaps and bounds. In 1990, the Times reports, the average was about $2,550 for those households that carried a balance. At the end of 2003, that balance averaged about $7,520 – an increase of nearly 200 percent!

And that's only credit cards. The average U.S. household owes mortgage debt, student loans and automobile loans, in addition to credit card debt.

Why are we doing this to ourselves? Personal income certainly hasn't risen 350 percent over the past 13 years. Let's see, that would mean that a person who depended on salary as the only source of income would have had to see a $35,000 salary in 1990 grow to $122,500 in 2003 to keep up with the extra credit load. Possible, but not too likely.

In fact, on the national level, the Bureau of Labor Statistics shows that aggregate U.S. personal income in 1990 was $4.9 trillion. In 2003, it was $9.2 trillion. The rate of growth? 188 percent — pretty far off from the 350 percent growth in credit card charges.

Again, let me reiterate. I am NOT saying credit is a bad thing. It is just the way many people use it. Taking out a mortgage to buy a house is a good thing (as long as people do not do what many did ....and what many will suffer for in the coming year ....by using the low interest rates then as an excuse to buy a house that is quite simply beyond their means. This leads to what is known as the '2 income trap,' and if one spouse is let go from work is is bye-bye house). Anyways, a mortgage is 'good' debt (geez, i feel like i am talking about cholestrol LOL). However having 10,000 dollars in credit card debt just so one can wear prada, or spending 30K on an entry level Bimmer when you belong to the Ford Focus group is just plain silly!

Anyways, Ocean View was correct about the way people have leveraged themselves. And there is a wealth of info to back him up. Easily.

Interesting data. I have seen similar examples from my own neighbors. My backyard neighbor bought a house five years ago with a $180K mortgage. Since that time they have refinanced three times and are now up to a $333K mortgage. I guess the house is worth that amount but I don't think there is much leeway there. To top it off, they have refinanced with one of the sharks of the mortgage business that will keep churning them higher and higher.

I also work at a law office where a partner handles a lot of marital dissolutions. It is tragic to see the net worth of the couples and how little, if anything, is left from selling off the house and satisfying all the outstanding mortgages, auto and credit card debts. No wonder the marriages split up with that kind of financial pressure.

My husband and I have tried to be very conservative about our debt. We hold no outstanding debt except for our home. We bought on a 30-year mortgage in 1992. We refinanced in 2002 from an ARM to a fixed rate and from the twenty years remaining on the original mortgage to a 15-year term. We still owe around $100K but the house is worth five times that amount right now so we are fairly secure. The payments, by the way, rely on only one income even though we are both working.

There are a lot of things we haven't done and I guess one could believe we missed out on fabulous trips, late-model cars, the latest fashions or electronics but we have plenty for our needs and are secure knowing we could hold on to what we have. We are dinosaurs, I guess, middle-aged dinosaurs. And we are happy and satisfied. What more could you want?

Interesting data. Thanks for the post.

I have seen that trend in my own town. My backyard neighbor bought his house five years ago with a $180K mortgage. Since then he has refinanced three times and is now up to $333K. The house might be worth that amount but it is close to being leveraged to the max. In addition, a partner at my law office does a lot of divorces and it is tragic to see how little money is left over after a splitting couple sells the house, pays off the mortgage, auto loan and credit cards. They are lucky to have $10K to split between them. It's no wonder some of those marriages broke up with that kind of kiving on the edge.

My husband and I have been very conservative in our debt. We don't use credit cards, buy autos outright and have only financed our home. We bought the home in 1992 with a 30-year ARM. In 2002 we refinanced to a fixed, 15-year term cutting off five years of our original mortgage. We now owe less than $90K on the house and it is worth at least five times that amount in today's superheated market.

Now some may argue that we have missed out on life's little pleasures like fabulous vacations, new cars, trendy clothes and cutting edge electronics, but we have plenty for our needs and to spare for things that really matter to us. What more could we want?

Interesting. Link?

The credit boom that has been going on for the last couple of years led to many speculative-grade firms to leverage and debt finance themselves up the wazoo.

Really? I've read that corporate balance sheets are flush with cash.

What started as a small deficit of about $50 billion among households quickly spiked to a deficit of more than $350 billion in the second quarter of this year.

And when compared to the $45 trillion or so in household networth, that's less than 1%.

Anyways, Ocean View was correct about the way people have leveraged themselves. And there is a wealth of info to back him up. Easily.

Great. He said: consider the effects of the baby boomers moving towards retirement - they are pulling their asset base with them - back when people owned their cars, their homes, didn't have credit card debt, etc. outside that demographic, most americans probably have negative actual net worth when you consider their mortgages, car debts, credit cards debts, education loans, etc.

Since Ocean View has posted nothing more profound than, "I know some people who...." maybe you can link to some of that wealth of info that shows those younger than boomers probably have negative actual net worth.

Should be easy for you. Thanks.

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