Underwater Car Loans ... Smart Buyers Beware ... Watch the Total Payments

Today Keenan wrote about the lasting effects of ongoing ignorance and being conned by others. While not exactly a con, we do often tell ourselves lies about the total price we pay eventually for the things we buy today.

And of course, the effect is often to enrich the sellers at our expense. In other words, and as a result of our own ignorance or neglect to view things honestly and openly, we're doing the conning. Then later we tend to blame the self-interested sellers for what we've allowed them to do to us. Strange world, isn't it?

Credit cards, home mortgages, student loans and auto loans come to mind. We'll take a brief look at car loans herein.

Car loans are a great example of buyers paying too much by choosing to believe they are getting a bargain and considering solely the sticker or 'on sale' price when buying.

Here's the truth. What matters most in car buying are the total payments required to fully pay for the vehicle, including total interest charges for the length of the loan. That's because the number of years the loan is outstanding will impact those total payments greatly.

So when buying a car, assuming the buyer is able to pay off the loan in two or three instead of five, six or even seven years, he should do so. And if that means buying a lower price car and delaying other big ticket purchases, then so be it.

The smart and informed buyer will make every effort to avoid starting and then getting 'deeply underwater' (balance of loan outstanding is higher than the value of the car) beginning when he drives away from the dealership. And he will realize that starting off underwater just means that the depth of the water will increase as time moves along. That's due both to the all-in charges and the depreciating resale value of the car over time.

Thus, first time smart and informed cars will purchase a lower priced or used car in order to build some equity in the asset purchased. They will then proceed to pay off the loan in a couple of years. At that point they own something of value which can help make the next purchase more affordable. Then the next one and so on.

To do otherwise means our could-have-been-smart instead of 'zombie' buyer is going to be 'upside down' for decades, and that's neither necessary nor an inexpensive way to go through life.

Leases and Lengthier Loans Can Reduce Car Payments has the story:

"CAR shoppers are increasingly favoring financial arrangements like leases and longer-term loans that allow them to buy costlier vehicles but with more manageable monthly payments.

Almost 27 percent of all new car transactions in the third quarter of this year involved leasing .... That’s the highest proportion (ever).

With a lease, a shopper pays for the car for a set period of time, typically three years. At the end of the lease, that person has the option of returning the car to the dealer or buying it. Monthly lease payments are generally lower than payments on a standard loan because they are based on the car’s depreciation over the lease period, rather than the full purchase price.

Consumers save an average of $84 a month on payments by leasing a new car rather than taking out a loan . . . . “When you lease, it really is all about the monthly payment,” said Philip Reed, senior consumer advice editor at the auto website Edmunds.com.

Shoppers who buy cars with loans are also looking to keep their monthly payments down, and one way to do that is to extend the loan term. In the third quarter, the proportion of consumers who took out car loans of 61 to 72 months — five to six years — reached record highs for both new (44 percent) and used (41 percent) cars.

Even longer loans are gaining popularity as well. New-car loans of 73 months to 84 months — six to seven years — increased to nearly 28 percent, and long-term loans for used cars reached a record high of 16 percent. . . .

But the lower monthly payments available with leases and longer-term loans come with some trade-offs.

Longer loan terms mean buyers will pay more in interest for the car over all . . . .

Leasing, meanwhile, can lock consumers into a stubborn pattern of monthly payments. . . . It is easy to overlook that at the end of the lease, there will not be a car to trade in to help finance the purchase of another one. That makes another lease more likely, so the consumer never has the benefit of a payment-free period, as when a shorter-term loan is paid off.

“It’s hard to break the cycle,”. . . .

Consumer Reports has a list of leasing pros and cons on its website.

Mr. Reed of Edmunds said the cheapest option was usually to buy a used car, perhaps with a small loan."

Summing Up

First, don't lease. If you do, you'll be making monthly car payments for the rest of your life, and never truly own a car.

Second, when buying a car, recognize that what really matters will be the total required all-in payments for the loan's duration --- and not simply the 'low' monthly payments.

Third, realize that in addition to the higher total payments over the term of any loan, the lower the value of the car will be if and when the loan is fully repaid.

That lengthy loan period in turn will result in a lifetime of 'underwater' car ownership where what is owed always exceeds what is 'owned.'

So be an informed buyer as a first time buyer, and if not the first time then the second or even the third time.  That will make you a smart buyer --- of many things.

By doing so, you'll both save money and truly own the asset you thought you owned. Then you'll be able to buy newer and better cars, and everything else, with all the smart money you've saved. 

That's my take.

Thanks. Bob.