One of the key benefits of buying a car with cash is you have complete ownership over that vehicle. Naturally, cash purchases are much easier when buying an inexpensive car from Craigslist or Marketplace, but consumers looking at new or lightly used models often don’t have tens of thousands of dollars at their disposal. Therefore, they need to take out a loan. Despite what some “financial gurus” would have you believe, borrowing money to pay for a car is not a bad thing, but it can put you in a difficult financial situation if you aren’t careful. Far too many buyers have found themselves underwater on their car loans — especially recently on EVs that have depreciated like rocks. Here is what that means and some ways to manage it.
[Writer’s Note: “Hello friends and fellow enthusiasts! Many of you remember me from “other websites” as the guy who gives practical car-buying advice. I’m happy to be helping my pals here at The Autopian as a contributor. My goal is to have a regular column where you ask me car buying conundrums/questions and I answer them. Send me your messages with the subject – “Autopian Car Buying” to Tom@AutomatchConsulting.com !]
Being underwater on a car loan means that your loan balance is greater than the market value of your vehicle. This is also known as having “negative equity.” For example, let’s say someone purchased a Nissan Rogue with an MSRP of $32,360. After their local sales tax and DMV fees were factored in, they had a total purchase price of $35,500. They financed this vehicle for 72 months at an interest rate of seven percent and didn’t put any money down, resulting in a payment of $605 per month. A year goes by, and this person decides they want to upgrade to a bigger car. Their current loan balance sits at $30,565, but their trade is valued at only $25,500. That puts them about $5,000 underwater.
Those who bought electric cars are facing an even more dire situation due to the accelerated nature of EV depreciation. I’ve spoken with folks who want to trade in their EV only to find out that the delta between the market value and the loan balance is upwards of $10,000 or more. If you find yourself in a situation where you are underwater, here are some options.
Hold On To What You Have
For most people, this is the best option. Being underwater only really matters if you are trying to sell or trade your car. The longer you keep what you are currently driving, the more usable value you can extract from it, and eventually, you will reach a point where there is an equilibrium between the market value and loan balance. Buyers should look honestly at their situation and determine if they really need to get another car or just want another car.
Perhaps your current ride is becoming an unreliable nightmare, or you have a growing family and can’t fit the kiddos into something small. If you determine that it’s critical that you need to move into something else, choose your next move carefully.
Bring Some Cash To The Table
If financing another car is what you need to do, bring cash to cover the gap between the value and the loan balance. While this is the most obvious solution, it is often the most ignored. Using the Nissan Rogue example above, if that buyer wanted to finance another car they should put at least $5,000 down (ideally more) so that the next loan is only for the replacement car.
Unfortunately, in today’s economic climate, too many people simply don’t have thousands of dollars in extra savings. If that’s the case, you may need to get creative
Try Leasing
A possible way to break the underwater cycle is to roll your negative equity over into a lease. Since leases often offer payments substantially lower than finance programs, and end at a fixed term, you can use the lease to “break the cycle” of the underwater situation.
Here is how this could play out in the case of the custom with the Nissan Rogue with $5,000 in negative equity. If this person was looking for something bigger with three rows, they could explore the Hyundai Santa Fe with a current lease special of $329 per month for 36 months with $3,999 due at signing (before tax). As I mentioned above, this person likely doesn’t have several grand to bring to the table to neutralize some or all of the negative equity, which means they need to roll both the $3,999 down payment and the $5,000 in negative equity into the lease. This would increase the base payment by about $250 and they would be looking at a total payment of about $580 per month (before tax). This is within the ballpark of their original loan of $605 per month. While they will not have any equity in the Santa Fe at the conclusion of the lease, they would be able to start fresh.
This is an area where leasing an electric vehicle can be extra beneficial since the lease programs offer super low payments compared to the sticker price, and the massive rebates and discounts can absorb most or all of the negative equity. However, due to mileage restrictions and other factors, leases don’t work for everyone. In that case, there is one more option.
Roll It Over Into Another Loan
If using cash to neutralize the negative equity isn’t available, and a lease won’t work, the absolute last resort is to take a loan out on another car and roll the negative equity over into that loan. Let me be clear, this doesn’t actually solve the problem of having negative equity and will often compound the underwater situation. All this solution does is allow the buyer to change vehicles, and they will likely have a higher payment.
Going back to our example of the Nissan Rogue with $5,000 in negative equity, if this person were to buy (instead of lease) that Hyundai Santa Fe SE with an MSRP of $35,775, maybe they will qualify for the 2.99 APR special for up to 72 months. Then they would be financing a total of $40,775 (before tax and fees) for a payment of $619 per month. That doesn’t seem too bad compared to the original payment on the Rogue of $605, but if this buyer’s credit score doesn’t qualify them for the low rate, and they are back at that seven percent interest rate, the payment jumps to $695 per month.
If you must rollover your negative equity into another loan, take the shortest loan term possible and shop around to find the lowest interest rates you qualify for. Also, plan on keeping this car for as long as you can, ideally well past the point at which it is paid off.
How To Avoid Being Underwater
Having negative equity is often a situation where an ounce of prevention is worth a pound of cure. There are a few key ways to avoid being underwater. First, use a sizable down payment. The more money you can bring to the table, the lower your principal balance and therefore the less chance of you being underwater because the value of the car will be greater than the loan balance. Second, choose models that retain their value. Brands like Honda and Toyota have narrow depreciation curves and retain value. Therefore, these models are likely to keep you in a positive or neutral equity situation. Third, don’t stretch your loan too far. For most people, the sweet spot for getting a desirable model with reasonable monthly payments is a 60-month term. With a hefty down payment, you can stretch as far as 72 months, but if the only way to “afford” your target car is to take out an 84 or 96-month loan, I would suggest looking at something cheaper to avoid the danger zone of negative equity.
Top graphic images: Nissan; depositphotos.com
YEAH TOM, I have said ever since the wonderful creation of the Autopian website they needed a financial expert and as I loved your work at the socialist car site I recommended you. Glad to see you are here it really is bringing the best from the political toxic sight and improving Autopian a great car site with few toxic people.
I’m just here to say how thrilled I am to see you here. I always enjoy your posts.
Being upside down on a loan is like a personal nightmare of mine, probably millennial trauma from becoming an adult just as the ‘08 housing crisis happened. We were very fortunate to be able to pay off my car this year with our tax return and year end bonus, so we are back to only the house loan again, it’s a good feeling.
Good to see you here Tom. We were expecting you..
Pardon me one moment. Ya-hooo! Great to see you here, Mr. McParland. I’ve spent way too much money on cars, but I’ve always made sure I’m not under water so I could sell if life turns south.
Wow! Tom’s here!
Seems like the lights might be going out over at the old lighting site.
Yeah, not much (if any?) reason to go there anymore now that Tom’s here.
Tom is finally here. Hooray!
A car is an expenditure, not an investment. The market value drops and continues to drop the moment you buy it. You buy it for the utility it offers you, like socks and underwear and toothpaste and fresh vegetables and other stuff you need to get along. All that stuff depreciates to pretty much zero as soon as you buy it and it doesn’t matter at all because you’re planning to use up.
If someone buys a new car that they can’t afford, with a long loan under bad terms, with nothing down, and then they decide to “upgrade” after a year, that doesn’t mean they’re “under water”, it means they’re “IDIOTS”.
Tell that to the mixed greens I have playing the long game in the vegetable crisper
that goes with everything that you buy, tools, TVs furniture… etc. Once you are past the return window you are boned, regardless if they were used or now
Nice to see you here Tom!
I have only ever had one car loan, so pardon my ignorance: what about overpaying? Are there any fees or fines associated with overpayments or do they automatically go towards the principal?
If you have discipline, this would give you some leeway and a longer-term loan would be less expensive.
Generally, paying extra brings down the principal balance, reducing interest accrued and shortening the term of the loan. It’s a very smart thing to do. There are some loans that do not allow pre-payment or extra payments, but those are rare.
It didn’t use to be that way; I remember trying to pay down my student loan and the lender would just sit on the money and not bill me until my scheduled payments caught up, all the while adding interest.
I did ten seconds of research and found out that pre-payment penalties became scarce thanks to the 2014 Dodd-Frank Act. Amazing to imagine a piece of legislation that actually helped everyday people – I am sure it will be reversed soon.
Sometimes you need to do the extra payment as a separate transaction and specifically mark it as going to principal. The banks want their interest profits, so they often make it difficult to pay ahead.
Yep, this was a requirement of my first mortgage. Even paying a little extra per month required 2 separate transactions.
Your loan would say if there were any “prepayment penalties”. If not, then you can make extra payments and it would normally apply to principal. What you do want to watch for is if the lender says that the additional payments apply to interest only. That does not reduce the principal first, which reduces the interest owed over the remainder of the loan.
Welcome, Tom!
I cringe a bit when I see having to pay $20-$60 per day for a vehicle (for several years). My circumstance has changed so that I do not need a car to crawl into my office in the next bedroom to work, so I’d probably pay the tax on a 401K withdrawal (I’m old, so no penalty) if my car completely falls apart.
Back when (2002) I finally found a perfect car for my needs, I spent $22K or so for a 6-speed hot hatch with some kind of car loan, but when we refinanced our house a few years later, “they” insisted that I either pay it off or roll that loan into our mortgage. So, that is also an option, as soon (maybe, some day) as the interest rates drop. I mean, mortgage interest is deductible providing you annually pay more interest than the standard deduction.
We also bought a 2-year-old used car and asked my mom for an interest-free loan ($25K), to be paid back monthly or whenever she wanted some casino money. So, that is also an option, asking someone for a loan.
First, glad to see Tom here. Second, great information in this piece that most of the commenters might think is common sense, but many out there simply don’t understand.
My wife and I worked diligently to pay off our vehicles and we continue to make “payments” to a money market fund so when the next car purchase comes we can (hopefully) purchase cash. Being freed of those payments is one of the best feelings in the world.
Agreed. Getting in a cycle of buying exclusively in cash allows you to purchase and own more than you could otherwise afford since you’re not paying a bank to use their money (assuming you’re not making more on your money than they’d be charging to borrow theirs).
The post-loan “payments” are a great idea.
That’s exactly what we did on both our cars and it’s wonderful. I’ve been underwater before and it sucks but my plan to avoid it is to never have another car payment.
Length of loan can matter. But when the captive finance arm subsidizes the interest rate, that long loan may make sense. Lower monthly payment and less total interest. Can be a win in some situations.
True, but keep in mind a low subsidized rate is often paired with the language of “up to” so if the lender offers 1.9 APR for 72 months, you can take the loan for 60 months and still get the 1.9 rate. Though I have rarely seen good subsidized rates at 84 months or longer.
Or you can take the long term and just pay it off faster than required. Nice to see you here, Tom!
Or sock away the extra into a repair account if taking a 6 year loan. The car will be out of most warranties at 5 years for the mainstream makes. Maybe slightly longer for luxury makes. Having to pay for a repair while still making payments would really bite.
Great point. This should just be a hard and fast rule for buyers stretching into a car loan. Do whatcha wanna, but don’t take on a term that’s longer than the warranty.
In the article example where the negative equity on the Rogue is rolled into the purchase of the Santa Fe, I have to wonder how likely a lender would be to loan $40,775 (plus tax & fees) on a car with an MSRP of $35,775. That transaction carries some significant risk for the lender, as the loan begins at more than $5k underwater and the underwater position would become more extreme for the first few years of the loan. Would that situation punt the buyer into a subprime loan with a correspondingly higher interest rate?
BTW – Do people still call this situation “upside down?”
“Upside down” is another term people use…often lenders allow buyers to borrow more money over the price of the ca,r depending on credit score they may go for a 110 to 120 percent loan-to-value ratio
Judging by videos which pop up in my Instagram feed, lenders have limits on how far underwater you can be – which prompts people to upgrade to a $50K car so that they can get financing, assuming a 110% limit – which gets really interesting by the third or fourth time they roll the loan over and are now forced to buy a Maybach SUV.
In my misspent yout I made many of these financial mistakes because I NEEDED that car. Now I lease it for 5 years, write off the payments and driving cost, buy it out if the deal is good or flip it for a new lease. If I keep it, I drive it until it’s dead. Only Toyotas and Hondas on my menu. The Subaru was good for a decade and a bit, but is suffering from electrical gremlins and rot. Still don’t completely understand why my brain shorted out when buying cars.
“Still don’t completely understand why my brain shorted out when buying cars.”
Because they’re very good at marketing them. When we’re young and foolish, we fall for the newer/brighter/shinier trap.
As we get older, we still feel the pull, but life’s hard lessons keep us in check.
That’s my experience, anyway.
Well said
‘You can’t fit the kiddos in something small’ is kind of a cop out. I had infant twins in rear facing car seats with a 2012 Honda Insight while my wife had a 2 door R56 Mini Cooper. It sucked in her car, but we made it work. My car was absolutely fine and the hatch fit a double stroller.
It’s not ideal by any means, but it always floors me that people go ‘Whelp, I’ve got 2 kids now, so I need to get rid of my Jetta for a 3 row SUV or a $50K mini van!’ It’s even LESS ideal to be in even MORE debt and a worse financial situation, IMHO.
As a parent of two I agree to a point. My Kia Soul is fine for most things, and the rear facing child seat stage only lasts so long. My wife had a Forester and we could fit most things in it no problem. However as the kids age and grow jamming everything into a small car becomes less and less fun especially if sports are involved.
When it came time for my wife to get something new we went larger (Sorento) because between our growing kids and their friends and rapidly aging parents we are finding that we are becoming the family taxi service more and more. We figure this car should last until our kids are basically grown and our parents have likely shuffled off this mortal coil so after this it’ll be back to something small. Also we are in a financial position to not have any issue buying something larger/newer at very low rates and had a large down payment.
The less said about using my Mustang as a family car the better.
People tend to forget that as you enter the “peak family” phase of your life, you may not just being carting around your kids. There’s the aging parents, pets, cousins, friends, etc.
Not that I’m saying that everyone should be out there buying 3-row vehicles they may or may not need, but that everyone’s deal is different.
No doubt, but you can usually see those things coming from a few years down the road and prepare for it. Obviously there could be unforeseen circumstances like a parent falling ill suddenly, or an unexpected pregnancy, but even THAT has nearly a year of runway. The USA (where I’m born and raised, to be clear) has far too much of a ‘I WANT THIS NEW THING AND I WANT IT RIGHT NOW REGARDLESS OF THE CONSEQUENCES’ and that’s what I see far more often when it comes to people buying new vehicles.
I’m also discounting people who get screwed by predatory buy here-pay here type shady used car lots where they’re underwater the moment they even look at the car because it’s the only place that would finance them for that $6000 car that is worth $1500 and is going to explode in 5000 miles.
We’re certainly a country that could use less people making 50k impulse purchases with 7-8 year loan terms.
As my kids get older (relatively, at 4 and 10) we need less space than before. That may change as their legs get longer and so on.
I love having a van, and we fairly often have more than just the kids in the car (in laws live with us half the year, etc.) and the utility is unmatched. But even a used van is expensive; fuel and maintenance costs aren’t as low as a run of the mill hatch or sedan. A large vehicle is not a requirement for a family of 4. It’s just a nice luxury.
Obviously I recommend anyone who is struggling to afford their Jetta to stick with it and not upsize to something with a much higher cost of ownership. I do sympathize somewhat with those looking for reasonably sized cars that work well for family duty though, there’s certainly not a ton of great options out there anymore.
Right like, I’m not saying having a bigger car is a bad choice in a vacuum. But the point of the article is that you’re NOT in a vacuum and you’re already paying too much for a car that you already have.
Financially it’s the stupidest decision you can make, especially because, generally, that will also incur higher fuel costs to go along with the additional space the car takes up. The best car is usually the one you already have and paying thousands more than retail for a different one because you don’t want to be minorly inconvenienced is just the epitome of American-ness.
I would agree that if you’re underwater on a car loan, the very, very last thing you should be doing is shopping for a car. Unless whatever you own has been such an irredeemable lemon of a car.
I would suppose this article is sort of a “so you fucked up bad, what should you do?” and Tom basically says that most people (and I would imagine most should be like, a 98% sort of most) should just keep the car.
Yeah the ‘you can’t fit the kiddos in the car’ line is what sort of triggered me because too many people think they need a Suburban or an LWB Expedition becuase they had a second kid. I see it in my neighborhood so often. I think I got a little triggered. Back to your regularly scheduled programming!
Second kid? I’ve known people who upsize with just 1st kid..and they upsize they’re house also!
I dont think they realize how much a kid will destroy their budget.
Seeing your by line absolutely made my day. Great to see you here Tom!
Glad to be here!
I have no reason now to visit the old site. Glad to see Tom here!!
Rob is still there, otherwise.. ehh.
Last time I was there, it was literally unusable on mobile due to ad quantity and behavior. Between that and the constant Cybertruck rage bait, It doesn’t much matter to me who’s left there.
Tom’s here??? Goddamn is this place killing it.
Welcome!
Welcome, Tom! Thanks for the explanation on leases. I’ve never considered doing one and wondered how they dealt with the down payment mentioned in the ads. Do you have to have cash for it, or a trade in, what about if you are returning a lease, etc. I guess I could do a lease if I had to, but my M.O. is to buy a car and enjoy at least a few years without a payment once the loan is settled. My wife’s current car is paid off and mine will be this year, and I figure that gives us 5 years to save before we give one of them to our daughter when she goes to college (unforeseen events notwithstanding of course).
A deeper dive into leasing is probably another post….if you have some specific questions please email me, my plan is to do a regular column where I answer these kinds of things – Tom@AutomatchConsulting.com
Yay, Tom McParland’s here!
Very cool to see some great commenters again!
Glad to see you here Tom!
Oh btw Tom… I forgot to mention that I’m glad you made it over here!
Welcome!
Thanks!
Let me be the latest to say welcome over!
I remember you from the Oppo days! Good times
Great article and welcome Tom!
I always get a little dumbfounded with how many people end up underwater and usually when there is no need! There is a used car dealership in town, not a pay here buy here by any means but their lot is filled with late model trucks and SUVs and have a ton of turnover. It seems people are buying these trucks, adding thousands of dollars in accessories, then getting bored? and decide to get something else. This place has had to expand to two lots because it gets so much of this business.
I’m not immune to impulse and certainly have done some irrational things but people who makes these kind of major, snowballing, financial decisions on a whim make my head spin.
I’ve had co-workers that will trade when old car just needs tires/brakes or some other $$ things they dont have ready cash for.