More buyers 'upside down' from longer car loans

by Center for Personal Finance editors

NEW YORK (4/6/06)--New data suggest that new car buyers increasingly put themselves in a precarious financial position by taking out five- and six-year auto loans, with some car buyers finding themselves "upside down" when they go to get their next vehicle (CNNMoney.com March 29).

Longer-term loans mean you pay a lot more in interest, and you run the risk of owing more money on the vehicle than it's worth (upside down), particularly if you have an accident or need a new car again within a short period of time. In the past, it was common for owners to trade in their older car and use the proceeds to pay off the remaining loan balance; if you're upside down on your loan, that's not possible. Now, it's not uncommon for a buyer to be upside down just a couple of years into a five- or six-year loan.

For the first time, more than half of new car loans were written for more than five years, with the biggest jump in six-year loans, according to a survey of member institutions from the Consumer Bankers Association. Less than two years ago, Bankrate.com (June 24, 2004) reported that 40% of consumers were upside down with their car loans.

Leasing is growing in popularity. J.D. Power and Associate's Power and Information Network reported that leases accounted for about one of five U.S. new-vehicle sales between December 2005 and February 2006--the highest level in five years.

Experts believe consumers are opting for longer terms and leasing because they want more expensive vehicles with luxury features, but they don't want a higher payment each month.

To avoid becoming upside down, consider these alternatives:

Don't finance a vehicle for more months than you think you want to own it.

Make the biggest down payment and choose the shortest-term loan you can afford.

Purchase a used car instead, or buy a vehicle that will hold its value longer.

Research your financing options at the credit union.

When shopping, focus on the price, not the monthly payment. If a salesperson asks you about your monthly payment goal, say you want to talk about price first and that you'll discuss financing later.

If you're sure you'll drive no more than an agreed-upon number of miles a year--usually about 15,000--and you take good care of your cars, consider leasing.

Talk to the credit union about gap insurance. If you total the car soon after it's purchased, gap insurance covers the difference between the value of your car at the time it's totaled and the outstanding loan balance.

Finally, if you find yourself upside down, try to hold onto the car as long as you can, or at least until the balance on the loan matches the car's trade-in value. Then try to sell the car yourself or bundle the negative equity from the car with a loan on a new car.

For more information, read "Gap Coverage Protects 'Upside Down' Car Buyers" in the Home & Family Finance Resource Center autos section.