The best way to turn things right-side up is easy, experts say: Keep driving the car until it's paid off.
Brian J. O'Connor - Detroit News - June 12, 2006
David Coates - The Detroit News
Michael Baskin of Gibraltar rolled over the balance of the unpaid lease on his Trans Am into the new loan for this 2004 Ford Explorer.
Zero-interest deals and long-term car loans are boosting sales, but they are producing one troubling side effect - a growing number of drivers owe more on their vehicle than it's worth at trade-in time.
Last month nearly 29 percent of U.S. car buyers found themselves "upside down" on their loans, owing an average of $3,789 more than their trade-in value - the highest level since September 2004.
Loan officers and car dealers call it "negative equity" - and there are a plenty of negatives to it:
- First, car buyers often pay more interest as they roll old upside-down loans into new car purchases.
- Second, they'll be saddled with higher payments that make it harder to save for their next car or keep up with their current loans.
- Third, those buyers are instantly turned upside-down in their new purchases, creating a vicious cycle of excessive debt.
Upside-down loans also dampen auto sales, says Tony Jerome Jr., general manager of Tamaroff Dodge in Southfield.
"It hurts us all the time," Jerome said. "Typically they can't do anything, which means we can't sell them a car. Sometimes you can, but some of the negative equity is ridiculous."
Longer car loans are the prime factor flipping car buyers upside down, experts say. Where the average car loan in 2003 lasted for 60 months, it's crept up to 64 months today, says Jesse Toprak, executive director of the Edmunds.com, a Web site for car shoppers. Part of the reason is the introduction of the 72-month loan.
"Seventy-two months is sort of becoming the norm," Toprak said. "Unless you put a substantial amount of money down you will have negative equity."
Another trend turning car owners topsy-turvy is no-interest loans.
It sounds like a good deal: All of the payment goes toward reducing the principal instead of paying interest. But buyers usually take the no-interest loans instead of a rebate that would cut the overall size of the loan.
"When they take that zero percent, they're doing that in lieu of $5,000 in rebates," Jerome said. "If they try to trade in early, they're automatically $5,000 the wrong way."
New cars depreciate rapidly in the first two years of life. The average car, says Edmunds.com, loses 25 percent of its value the moment it's driven off the dealer's lot.
Meanwhile, many loans have buyers paying mostly interest at the beginning and making little headway into reducing the principal amount owed on the car.
It could be worse. The increase in upside-down buyers comes at a time when used-car prices are actually getting higher, said Toprak. If they were dropping, car owners would be in even deeper.
That was the case in late 2003 and much of 2004, the last time upside-down loans were worse than they are now. Used car prices were down and buyers were looking to trade in cars they bought in the desperate deals offered after the September 11, 2001 attacks. By September 2003, 33.5 percent of buyers dragged in cars with negative equity averaging $4,133.
Buyers frequently just don't do the math, focusing instead on getting the most car for the smallest monthly payment, says Alan Helfman, vice president of River Oaks Chrysler-Jeep in Houston. "A lot of people put them on five-year loans so they can make the payment affordable, and it depreciates faster than they can catch up."
But not every upside-down buyer has a choice, said Dorothy Guzek, a budget counselor with Greenpath Debt Solutions in Troy.
She described cash-strapped clients who need cars to get work but can't afford much, and end up financing undependable vehicles. If the car breaks down, it's often easier to finance another purchase than to find the money for repairs, so they roll the unpaid balance on the broken-down old car into a loan for another jalopy.
"They can't afford to pay for a new transmission, but there's someone who will put them into a new car loan," she said.
She describes one client who went through four different car loans, first trading down to a cheaper car, then seeing another totaled in a wreck. By the time he got to the fourth car, the monthly payment was up around $750.
The best way to turn things right-side up, financial planners say, is easy: Just keep driving the car until it's paid off.
In other cases, it makes sense to trade the old car in on something that comes with a big rebate, move into a lease or refinance the loan.
Take the case of Michael Baskin, a guy who'll always remember his first car -- even if he can't forget about the payments.
Only two years into a five-year lease, Baskin hit the mileage allowance on his pewter 2002 Trans Am convertible. Faced with extra charges that rolled up with each mile on the odometer, Baskin traded it in for a new truck two years ago, bundling the last three years of lease payments into the new loan. He got out from under, but only to face a whopping new monthly payment of $655 at 9 percent interest.
Baskin, 24, got a little breathing room when he refinanced the loan at a percent, saving him more than $150 a credit union, which cut his rate to 6 month.
But with the miles the Gibraltar salesman is racking up on his Ford Explorer, he knows he'll be looking for new transportation as soon as it's all paid off.
"By the time I have this paid off I'll have driven it into the ground," he said. "I'll be back to square one."