July 30, 2013

USA TODAY reported that many auto buyers owe more on their cars than they are worth. Edmunds.com says 40% of new-car buyers are “upside down,” with an average negative equity of $2,200.

It’s a growing problem largely because of long-term loans: Five- and six-year loans make monthly payments lower, but the longer the loan the longer it takes to owe less than the vehicle’s depreciating value. The Consumer Bankers Association reports 82% of new car loans last year were longer than four years; 31% were longer than five. In California, some dealers are writing seven-year loans.

In-the-hole buyers usually add the amount they owe on their trade-in onto the loan for a new car. And they often stretch out the new loan, which keeps the cycle going.

The problem has spawned a new profit center for some dealers: gap insurance, which pays the difference between what’s owed and what regular insurance will cover if a vehicle is totaled in a wreck or stolen.

Editor’s View: All the more reason to encourage counselees to break the cycle of financing cars by keeping cars longer, buying a quality used car when one’s current car needs to be replaced, and paying for cars with cash. As people consider buying their next car, dependability should be a key factor. To learn more about how to create your personalized debt elimination plan, check out our Freed-Up from Debt Home Study Course.