‘Upside Down’ Car Deals Turn Finances Inside Out

By Michelle Singletary

To this day, I’m amazed at how my grandmother, who didn’t earn much, could manage to pay off her auto loans early – sometimes in half the usual four-year term.

In fact, my grandmother once paid off a loan so early that the lender called and accused her of falling behind on her payments.

Well, Big Mama gave that person such a tongue lashing that the devil would have covered his ears.

Given her philosophy about buying and paying for a car, Big Mama would be astounded (as I am) at the number of car owners increasingly extending their auto loans out five, six and in some cases as much as eight years.

The average car loan today is 63 months, compared with 48 months just five years ago, according to AAA. Longer car loans also have led to another trend – a significant increase over the past three years in the percentage of new-car buyers “upside down” on their trades, meaning the loan balance is higher than the value of the car.

In 2001, 25 percent of trades were upside down, according to retail transaction data from the Power Information Network, an affiliate of J.D. Power and Associates, a marketing research firm. Now, 38 percent of car buyers owe more on their trade than the vehicle is worth.

Edmunds.com, an online resource for automotive information, found a similar trend with only slightly different percentages. The company began looking at this trend of longer auto loans and negative auto equity in January 2002. The findings are disturbing.

Edmunds’ most recent data through March of this year showed car buyers had an average loan term of 61.5 months, and the average amount financed was $23,363.

Get ready to gasp (I did). Almost 28 percent of new car owners owed at least $3,708 on their previous loans. That means these people either rolled $3,708 into the $23,363 financed, used a rebate for their new car to make up the difference or came up with the extra cash to pay off the old loan.

“This certainly is not a good thing for consumers,” said Jesse Toprak, director of pricing and market analysis for Edmunds.com.

The word crazy comes to my mind. So why are people finding themselves upside down? Here are two reasons.

First, people are buying more car than they can afford, so they often need to stretch the payments out further.

Second, far too many consumers walk into a dealership with one thing on their minds.

“People are shopping for a monthly payment and not looking at the total cost of owning the car,” Toprak said. “It’s the worst way to shop for a car.”

I always find it helpful to look at the math, so I asked Toprak to run some financing scenarios for me.

For example, take someone buying a 2004 Ford Taurus SE four-door sedan. After a $3,000 rebate, Toprak estimated a $17,334 loan at 7.5 percent for 72 months.

In two years, the loan balance would be $12,395, but the car would be worth only $7,117, according to Edmunds.com’s calculations.

That means if the car was traded in after two years, you will be upside down by $5,278. Wait another year and the car will be worth $5,694, and you’ll still be upside down by nearly $4,000.

Well, you say, what if I bought a top-selling car that is known to hold its residual value?

OK, let’s look at a 2004 Toyota Camry LE four-door sedan. In this case, the amount financed is $19,810. In year two of the loan, your car might be worth $11,726, Toprak estimated.

However, the loan balance would be $14,166, making you upside down by $2,440. It’s not as bad as the Taurus, but you still won’t have any equity because of the length of the loan.

Keep in mind with a longer-term loan, the value of the car declines faster than the loan balance.

And let’s not forget that the longer the loan, the more interest you pay. Suppose your auto loan is $24,000. What a difference a year could make.

A 60-month loan at 6.5 percent would cost you $470 a month and $4,175 in total interest payments. Now stretch the loan out another year to 72 months and your interest rate could go up to 7.5 percent (longer loan, higher interest rate), Toprak says.

True, your monthly payment drops to $415, but the total interest on the 72-month loan would come to $5,877. I would think you might want to ask yourself if the car was worth another $1,700.

“This is not like buying a house, which has the potential to appreciate over time,”said Charlie Vogelheim, executive editor of the Kelley Blue Book. “People either need to show some control in what they are buying or keep what they have a little longer.”

Amen to that. Actually, I think calling this condition upside down is appropriate. Because if you trade in a perfectly good car on which you still owe a lot of money that will then have to be rolled into yet another car loan, it’s clear that when your daddy or somebody was bouncing you upside down as a kid, they dropped you on your head.