[edit] Upside Down Auto Loans

[edit] What is an “upside down” loan?

It is estimated that nearly 40% of all car shoppers are upside down on their auto loan. Being upside down on a vehicle loan means the owner owes more on the car than the car is worth, so when the car buyer goes to buy a different vehicle, they must take into account the difference between what the dealer offers as a trade-in value compared to the amount owed on a the loan. For example, if a car owner owes $10,000 on a car valued at $8,000, the owner is $2,000 “upside down.” If the dealer offers the owner only $6,000 then the owner would be $4,000 upside down. This money has to be accounted for somewhere in the purchasing process. The car buyer can either pay the money outright to settle the loan, negotiate a better trade-in price with the dealer to minimize the upside down amount, or re-finance the upside down portion by rolling it into the new vehicle loan.

Unfortunately for car buyers, the last option is the most common scenario to play out on the dealership showroom. This is undesirable from a financial standpoint because the car buyer ends up essentially paying for the old car and the new car at the same time. These days when dealerships and manufacturers are offering deep discounts on new cars, the value of used cars decreased proportionally. As it becomes more economical to purchase a new car, the market for used cars diminishes.

The causes for being upside down on a vehicle loan are, in part, a side effect of increasingly easy financing terms, lower down payment requirements, rapid vehicle value depreciation, and longer loan terms. It’s easier than ever to get over-qualified for a vehicle purchase, and most dealerships run zero-down purchasing plans at various times throughout the year. Combine this with a payment plan that can last up to a whopping 72 months and the massive depreciation that occurs with most new vehicle purchases, and you have very little equity and a whole lot of debt wrapped up in the vehicle. This is the perfect set of conditions for getting upside down on the loan.

There are some tactics you can use to avoid getting upside down on a vehicle loan. Use the following guidelines to ensure that when it comes time to trade in your car, you are not put into a compromising situation because of your existing loan:

• Choose the shortest loan term you are able to make payments for. Loan term lengths have been creeping longer and longer over the years. Popular loan terms are 36, 48, 60, and can now stretch up to 72 and even a whopping 84 months. Considering that the average buyer only owns their vehicle five years, stretching vehicle payments longer than that is risky business, plus the longer your term the more you pay in interest.

• Put the most money down as possible when purchasing the vehicle. The more money you put down, the lower your payments, the less interest you pay, and the more equity you have in your vehicle up front.

• Buy used instead of new. Buying a used car means that you are buying a vehicle that has already depreciated part of its value, and the sticker price will reflect this. Basically, the by buying used you are letting the first person who purchased the car take the depreciation hit in exchange for the niceties of owning a new vehicle.

• The best plan of attack to avoid an upside down loan is paying for your vehicle in full before buying a different new or used car. Whether this means making all of the payments as planned or paying off the loan in a lump sum before buying a new car is up to you. The benefit to this is that you will not have to finance part of your existing loan in order to purchase a new car and you will save a substantial amount of money in the process.