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A growing number of new car buyers are finding they owe more on
their existing car loans than the vehicles are worth as trade-ins.
The phenomenon, known as being "'upside down" on a loan, is the
result of a confluence of changes in the ways Americans buy and
finance their vehicles.
To begin with, the prices of new cars and trucks have been held down
as manufacturers offer incentives and rebates to lure purchasers. As
new car prices flatten, so do resale values. Buyers, meanwhile, are
choosing increasingly longer-term loans, sometimes extended over 84
months, to reduce monthly payments.
The result is that a consumer who trades in a car that isn't fully
paid for can end up wrapping the loan hangover into the financing
for a new car, greatly increasing the cost. Or, if a car is
destroyed in an accident before it's paid off, the insurance
settlement may not fully cover the outstanding loan.
The amounts consumers are upside down are substantial, experts say.
"More than a quarter of buyers are upside down when they come in,
and the average is nearly $3,800," said Bob Kurilko, a vice
president with Edmunds.com Inc., an auto information publishing
company based in Santa Monica, Calif.
This loan overhang has implications for both trade-ins and insurance
recovery, he pointed out.
Here's the math: Say a consumer buys a $25,000 car and begins making
payments of about $500 a month, based on a 6 percent interest rate.
A tree blows over in a storm, flattening the vehicle. The insurance
company agrees to pay, but values the car at just $22,000; the
consumer is still on the hook to the finance company for $3,000
more, which must be paid out of pocket.
Scott Jones, 43, a New York free lance photographer, said he was
aware of the risk of becoming upside down on a car loan when he went
shopping for a new vehicle last spring.
"I read about it on some of the Web sites, and I tried to shop
carefully to avoid that trap," Jones said. His strategy, he said,
was "to buy a reliable car and pay it off as soon as possible."
Jones' choice of a vehicle was a Honda Odyssey minivan, which he
believes will hold its value better than some other vehicles. He
made a cash down payment to reduce the size of his loan, and then
financed the balance over six years, though he said he may try to
pay it off earlier than that.
"I figure I'll be driving it for at least 10 years -- long after the
loan is finished," Jones said.
Brian Reed, a vice president at Capital One Auto Finance, based in
Plano, Texas, said a major contributor to the problem is that
consumers have sought longer loans to hold down their monthly
payments.
"In the late 1970s and early '80s, most loans were for 36 months,"
Reed said. "Now, the average term is about 58 months, and some
lenders go as long as 72 months or 84 months."
Consumers with long-term loans who trade their cars frequently will
have built up less equity and be more likely to be upside down, he
pointed out.
The best strategy, Reed said, is "to try to match the term of the
loan to the time you intend to keep the vehicle."
Rob Gentile, director of automotive information products for
Consumer Reports, based in Yonkers, N.Y., said consumers who know
they're upside down on loans often don't bargain well for new cars,
since they're distracted by how that unpaid loan is going to be
handled.
"Consumers should settle on the price (of a new car) before anything
else," Gentile said.
Gentile also recommends consumers finish paying down a loan before
they trade a vehicle, especially if it's been a good, reliable car.
"If you roll what you owe into the new car loan, you're financing
the old car at the same time you're financing the new car," he
pointed out. "That will cost more in interest -- and your monthly
payment will have gone up, too."
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