How To Avoid An “Upside Down” Car Loan
We have already written on how to avoid getting caught in an upside down car loan and ripped off at the car dealership – see “You Can Get A Bad Credit Auto Loan, But What Then? Know Your Stuff Before You start shopping !” This article and others like it are on our website and blog and we hope you will read them before you purchase your next vehicle.Since both my daughter and I have sold cars and have seen the problem from the inside we know, you can’t say too much” about this problem.
Of course one of the very best ways to get the best rate on either a new or used auto is to be pre-approved BEFORE you go car shopping. This is important because it puts you in the drivers seat as far as interest, amount of the loan etc. All the factors that can cause you to have an “upside down car loan.”
“Upside down” is the term car dealerships use when you owe more money on your car than it is currently worth. Everyone knows that a new car depreciates when you drive it off the lot - and we accept that - but you should not pay one penny more than you have to in either value or financing!
With any kind of new loan, whether home or auto, the borrower is paying more on interest than on principal for the first two or three years. That’s just a fact you can’t avoid. If you start out owing $20,000 on a car loan and are making $500 payments, the interest each month for the first year or so is $300 or more, so less money is applied to the actual amount borrowed during this period. Hence, having an “upside down car loan.”
While everyone is upside down the first year or so, we’ve both seen people 3 and 4 years into a loan and still severely upside down. Why? Because they were so enthralled with the “something new and shiny” syndrome that the salesman was able to convince them to buy that new car before they really sat down and thought about it.
There are several ways you can keep this from happening to you.
Before you go shopping know how much you can afford per month and the type of vehicle you want. Do your comparative shopping on the internet ahead of time so you are educated on pricing.
Contact a lender and get pre-approved for the loan. We have lenders on our site that will pre-approve you then give you a blank check and a letter to take to the dealer.
To avoid becoming “upside down” on any loan it is best if you can put at least 20% down. This will probably mean that you purchase an automobile lower down the food chain than you really want. A $25,000 car would require $5,000 down to accomplish this but a $12,000 car would only require $2,400 down. If 20% is not possible get as close as you can.
Down payments also “pre-purchase” the warranty and gap insurance so that they aren’t part of the payments. This way you are ONLY paying on the car, and not on those extras that don’t really ad value to your car, but are important to have.
Finance the loan for the shortest time you can afford. I can personally remember when 60 month loans were becoming popular. Now of course they are longer which keeps you in debt longer. If you are not pre-approved a lender will often try to “trick” you into stretching your payments out longer to make them smaller, when what you really want is for the lender to lower the price of the car to make your payments smaller!
Give serious thought to GAP insurance. GAP insurance covers the difference between what you owe and the car’s blue book value in case of an accident that totals the car. So if your car is worth $10,000 and you owe $12,000 you are on the hook for the remaining $2,000 when the insurance pays you off and that could be huge!
Consider purchasing a used car instead. Since most of the depreciation has already occurred your car will hold its value longer. You can qualify for a pre-approved used car loan just as easily - as long as the mileage is 50,000 or less. A car that sold new for $17,000 will sell 1 to 2 years old for $13,000 used which is much closer to it’s true, current value.
Sell your old car yourself instead of trading it in. If you can afford to wait for the money you can usually get more on the street than you will at a dealership.
The biggest way to keep from being upside down on a car loan is pre-approval . That makes all the difference!
By Dewey Kearney
