Upside down car loans can be expensive

It’s a great time to buy a car if you can qualify for the occasional super-low interest rates offered as a promotion by the auto companies. Sometimes, these offers come with interest rates as low as 0% annually. That’s great, as no one wants to pay interest. But there’s a downside - you can be “upside down” in your loan, and that can have negative ramifications.

More below.

Negative equity can be pricey if you need to sell

Buying a new car is an expensive thing to do, but millions of people do it every year. Few people pay cash; most finance the car over a period of a number of years. With prices of cars getting higher and higher, the length of loans gets longer and longer, and buyers pay more and more interest to finance them. This borrowing process can lead to a problem that often catches buyers by surprise - negative equity, or being “upside down” in your car loan.

Negative equity is the result of being in a situation where the amount you owe on your car or truck exceeds the market value of the vehicle. That’s not a problem if you intend to pay the car off in time, but what happens if you want to sell it, or worse, lose the vehicle as a total loss in an accident? In those cases, you will have to pay the difference between what you owe and the value of the vehicle out of your own pocket.

How do people get upside down in their car loans? Here’s how it happens:

• Depreciation - Cars, on average, lose about 25 percent of their value the minute that you drive off the lot. Even if you took out a promotional, 0% loan, a $20,000 car is worth about $15,000 the minute you start the engine. But you still owe $20,000 on it.

• Longer loans - The average car loan now runs some 64 months, compared to 36 months about 20 years ago. The terms are getting longer, as more and more buyers are electing to finance over 72 months.
• Promotional interest rates - True, 0% is a great deal, but people like to get the cheapest possible loan, so they often tend to finance longer than necessary. It might be a good idea to take a rebate that will lower the price of the car instead of the 0% interest rate, if you have the choice. It’s all about paying as little as possible in total, not paying as little as possible per month.
• Trading in early - People often trade their vehicles in for new ones while they still owe more than the old car is worth. If you are trading the car in for a new one, you can often roll the remaining balance into the new loan, but if you do this repeatedly, you will eventually end up with huge monthly payments for a car that isn’t worth all that much. If you do this regularly, such as every two years, you can easily end up finding that several hundred dollars a month in car payments are actually going towards retiring the balance on your old car.

The cheapest way to avoid being upside down? Drive your car until you have paid off the loan.

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