Most of us do or will at some point buy a car. However, some of us owe more on the car we 'bought' (with borrowed money) than it is worth. Too many cars are 'underwater' and the result is that the otherwise happy car buyer is then 'upside down' on the loan. And the reason why is both a simple and unnecessary one.
When the purchase price is otherwise unaffordable, the car dealer and lender simply lengthen the number of years for the required repayment period on those car loans. As a result, and well before the time the car loan is paid off, the car isn't worth the balance outstanding on the loan. We're 'upside down' or 'underwater.' From the time of purchase, the resale value of cars falls rapidly. Thus, the longer the loan is outstanding, the more the car depreciates.
And even for those buyers who don't end up upside down or underwater, often they're stretched too thin making the burdensome monthly car payments. That's not a good situation, and buyers should not borrow more money than they can reasonably afford to repay in a few short years. Sadly, that's not the custom and practice followed by many buyers today.
How to Buy a Car on Credit is subtitled 'These Strategies Can Save You Money and Limit Your Risk.' The article has some good advice and includes some interesting facts about car buyers:
"Car buyers are taking out loans more frequently, borrowing larger amounts and planning to pay the money back over longer periods. Before following in their tracks, take a few steps to protect yourself.
Among them: Ask the financing office at the car dealership to beat the lowest rate you qualify for from other lenders, and avoid borrowing so much that normal depreciation could soon leave the car worth less than the outstanding loan balance.
Put down a significant down payment, which can offer protection against the car losing value. And if you opt for add-ons that dealers often offer, such as extended warranties, don’t add the cost to the loan balance because that also could increase the risk that you will owe more than the car is worth.
Lenders originated nearly 19.2 million car loans and leases in the first nine months of 2014, up 4.7% from the same period a year prior and 64.1% from that period in 2009, during the financial crisis .... Nearly 24% of new-car loans given out to buyers in the quarter had repayment periods of 73 to 84 months; just two years prior, that figure was 16%.
Meanwhile, the percentage of loans given out in the quarter that are due to be paid back in five years or less has dropped.
Low interest rates are fueling the market. The average interest rate on a new-car loan is 4.5%, according to Experian. Some lenders charge the most creditworthy borrowers as little as 1.5%, and the financing arms of some major car makers offer no-interest loans. . . .
Extending the repayment period can make loans seem even more affordable. A $20,000, four-year loan at 4.5% interest requires a monthly payment of $456. That payment drops to $278 with a seven-year loan at the same interest rate.
But longer-term car loans can pose problems, including larger overall interest payments. On the same seven-year loan, the borrower will pay $1,461 more in interest than on the four-year loan. In addition, longer-term loans typically come with higher interest rates, making the potential gap even greater.
Moreover, most cars start losing value as soon as they leave the lot and continue depreciating over time, so borrowers can end up owing more than the asset is worth in a hurry. . . .
Car buyers who decide to get a loan should talk to lenders before going to the dealership. At LightStream, an online lending division of SunTrust Banks , borrowers can get fixed interest rates between 1.99% and 2.99% on personal loans of $10,000 to $100,000 if they want to use the money to buy a new car and will pay off the loan in two to five years. Capital One Financial offers three-year new-car loans at fixed interest rates as low as 2.39%.
Borrowers should consider checking in with credit unions. The average interest rate at such lenders on three-year new-car loans was 2.51% as of Dec. 30, compared with 4.68% at banks, according to SNL Financial, a financial-information firm based in Charlottesville, Va. At Navy Federal Credit Union, the largest credit union in the U.S. by assets, the fixed interest rate for a new-car loan of up to three years is as low as 1.49%."
See also Car Loans See Rise In Missed Payments.
Summing Up
A car is definitely a nice and often necessary thing to have.
That said, it's only a means of transportation and having the 'car of our dreams' should not become the financial nightmare that it often does.
When purchasing, the buyer needs to make a substantial down payment, followed by regular monthly payments sufficient to pay off the remaining loan balance within two to three years.
At that point the buyer will have substantial 'equity' in the car, and as a result, the next purchase will be much easier to make. And much more affordable.
That's my take.
Thanks. Bob.
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