Cars are a fundamental necessity
In our society, cars are a fundamental necessity, a necessity that the vast majority of people wish to have at their disposal to be able to pass from point A to point B with relative ease. Although walking, cycling and public transit are an option, most motorists prefer the added convenience of having access to their car, truck or other motor vehicle. After all, it is sometimes better to have a nice, warm car in winter than to wait for the bus outside, especially when you are late for work or need to move quickly. The only problem is that cars are expensive. Whatever the year, the make or model of your car, or the mileage traveled, you will have to dedicate some of the hard earned money to keep it on the road anyway. Unfortunately, car costs go well beyond the initial price. At first, you might think that attractive financing rates and rave reviews are enough to justify the purchase of a vehicle, especially a brand new one. However, buying a car, whatever its nature, is a huge financial responsibility, which should not be taken lightly. This is how many drivers end up with negative equity in their car after their car loan. The temptation to own a vehicle often trumps their hesitation, so they commit to a car loan that they can not reasonably afford. Shortly after, they find themselves with considerable debt and do not have the financial means to repay it. That said, if you are a driver and your car loan is more expensive than your car, or if you think it will be soon, stay with us, we will discuss everything you need to know below.
What does it mean to be “upside down” with your auto loan?
One of the most important things to consider when it comes to the financial side of owning a car is the speed with which it declines, especially for new vehicles. In fact, most cars lose about 11% of their total value the minute they leave their dealership and about 25% at the end of the first year of driving. Then, once the car has lost much of its value, it’s extremely difficult to recover that value or get close to what you paid, if and when you sell it.
As we said, this is especially true for new cars. Most people can not afford to buy a new car at one time. They have to get a car loan and pay it back slowly over the years. This is where financial problems often start. For more information on vehicle depreciation and negative equity, visit the Government of Canada website. Essentially, being “upside down” on a car loan means that you, the driver, have started paying more for the car than it really is worth, bringing you into the negative equity zone. Fairness refers to how much money you have invested in the car, similar to the one you earn by mortgaging a house, except that you can not always use it to buy other things, as you might get a mortgage line of credit. To use it, you must own the car in its own right and use it as an asset as a guarantee, which is not an option when you are paying for a car loan.
When financing a new or slightly used car, drivers generally have two options. They can get a car loan from the dealer or their other lender, which for the most part means the bank, credit union or other financial institution. A driver can “buy” a car and then reimburse it over a period of time with weekly, bi-weekly or monthly payments, which include interest. However, the lender will retain the rights to the vehicle itself until the full amount of the loan is paid. Thus, if the driver fails to track his payments, his lender (or his dealer) has the opportunity to repossess the car. Thus, to avoid such an event, auto loan lenders will generally allow drivers to reduce their payments or extend their schedule, which will increase their amortization period. These extended payments, combined with other car-related costs, such as fuel, and the rapid depreciation of the vehicle, can cause the driver to spend more on the car than he or she estimated, thus putting them in the position back on their loan.
Other elements causing negative vehicle equity
Payments are not the only things that cause drivers to be upside down on their loans. When buying a vehicle from a dealership, drivers also have the option of paying a deposit in order to pay more quickly. However, if they choose not to do enough or do not do enough, their payment term could be extended again, which would give them negative equity somewhere in the future. If the suggested down payment is usually 20%, it should be at least large enough to cover the cost of the immediate depreciation of the vehicle. Suppose the car costs $ 30,000 but has lost 11% of its value once you leave the car park. Thus, your down payment should be at least $ 3,300, plus if possible to reduce your payment term.
Negative equity can also occur if your interest rate is too high. If your credit score is not favorable or if your financial situation is too risky to benefit from a more reasonable rate, the interest paid on your periodic payments can also lead to financial difficulties. Whether you have bad credit or not, it is often a good idea to obtain prior approval of your car loan through your financial institution. This will not only allow your lender to know that you are seriously considering buying a car, but will also give you a better idea of the interest rate you will get. If your rate ends up being so high that you think you will have trouble managing it, you may want to wait until you can improve your credit and reduce it.
The car itself could also be the problem. Another interesting aspect of auto financing is that it allows the driver to buy a car that he would not have been able to afford at the beginning. If you want a luxury model, you will have to pay a luxury price. Payments seem reasonable at first, especially when they are reduced to a few hundred dollars a month and you earn a decent income. Then, a few years later, you always pay for a Mercedes that you can not afford. Who knows? You could suffer a sudden job loss or other financial emergency. So while the appeal of a luxury vehicle can be powerful, it is best not to give in unless you are absolutely sure you can afford it. If this is not the case, consider buying an item at a more reasonable price, even if it is not as attractive as you would like. You can also try to finance a used car until you can afford a little more.
How to get out of your car loan upside down
If you read this article, we will assume that you are already upside down on your car loan or that you are about to become one. If this is the case, you can do some things to at least minimize your debt and get out of it faster than if you leave it to chance. For the sake of argument, we will also avoid you to extend your payment period or reduce your monthly payments. Both options can help you immediately, but these are two ways to extend your debt longer, which means you’ll end up paying more. So here are some more conventional solutions with which almost all drivers can start.
Save more, spend less
Quite basic, probably not the most important factor, but a good way to at least improve your finances in general so that you have easier to make your payments. Save as much and spend as little money as possible. Buy discounted consumer goods, sell everything you do not need, even find a second job or ask for a pay raise if needed, and keep the extra money in your savings account. Then use your savings to repay your debt aggressively. You can even increase your payments, reducing your payment time.
Reduce your vehicle costs
When you have a new car in your driveway, you will want to drive it. However, the more you drive, the more you will spend on gas. Even electric cars can cost a few dollars an hour to charge with a sidewalk port, depending on the city in which you live. In the same way, the more your car wears out, the more its value depreciates quickly. Dealer cars, new or used, usually carry a warranty against certain problems such as basic maintenance and factory deficiencies that will be covered by the dealer himself, accidents or any other incident of which you are the cause. You can also reduce the cost of your car by using public transportation (or other means of transportation) or carpooling, where possible. If you plan to drive everywhere, try to buy a car that has good fuel consumption and a reputation for reliability.
While this may hurt you, trading your car for something more reasonable could save you a lot of stress on the road. You can bring your vehicle back to the dealer, exchange it for an older model or something more used. Admittedly, you will probably suffer a significant loss compared to what you initially paid, and you may also be upset with this new auto loan. However, your monthly payments and your insurance rate will probably be much lower, which will shorten your payment term and significantly reduce your debt load. The problem here is that not all dealerships offer the option of recovery, so you should discuss it with the dealership of your choice before buying the car.
Again, this is often an inconvenient and discouraging solution that most people only use as a last resort. So sad that it may be, given the fact that you have probably already spent a lot of money and effort on your car, selling your car could be the only way to get rid of your debt. Although selling does not seem like a good idea at first, it’s better than finding yourself indebted for years and years. You already pay more than the car is worth, so it is best not to exhaust all your savings. Advertise your car on any used items site. Since technically you do not own the car until the total repayment of your loan, you must contact your lender and request a transfer once you have found an interested buyer. The problem here is that, for most lenders, the total amount of the loan must be paid before the title of the car can be replaced by another name. This can be done using either the seller’s money or the buyer’s money. If the buyer pays immediately, he can make two payments, one to you for the car and the other to the lender for the rest of the loan. Once again, you will probably not recover what you have already invested in the car, but you will be able to free yourself from your debt faster.
Open a line of credit
This is not always desirable, simply because, if it is not managed properly, a line of credit can put you into debt even more cruelly than before. That said, opening a regular line of credit or a mortgage line of credit can help you pay off your car loan faster. If your financial situation is good, which means that you have a favorable credit, a stable source of income and / or have sufficient equity in your home, your financial institution should give you the appropriate amount. Just make sure the payments you make to your line of credit are easier to manage than your auto loan, that you make them on time and at least meet the minimum monthly payment to avoid defaulting.
Pay more than the price
In the end, you will always end up paying more than a car is worth, especially if the car is new or has been used very little (think of giving a lease) at a dealership. This is mainly due to interest payments associated with all forms of financing. Dealers and other lenders have to charge interest on their products, otherwise they will not make a profit. When you buy a car from a dealership, you not only pay the original price, you also pay interest. Therefore, whatever the form of the car or the speed with which you manage to repay it, you always pay more than what the car is worth. However, the key is to determine how much you will eventually pay and try to reduce that price as much as possible before signing a contract.
That does not mean that financing a vehicle is always a bad idea, far from it. As we mentioned, the simultaneous purchase of any vehicle, let alone a new one, is not an option for the majority of drivers. It is inevitable that, if you do not buy your car from a private seller, you will have to take for your money. However, there are benefits to vehicle financing. For example, a list of complete and timely car payments is a good way to increase your credit score. Remember that it is necessary, if you opt for financing, to really consider all the other areas in which you will spend money. It is likely that once you have purchased the vehicle, it will not stay in your garage covered with a sheet of plastic forever. At some point, you will want to drive it and breathe that new car smell.