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An upside-down time bomb a threat to buyers, dealers

By Jason Stein
AUTOMOTIVE NEWS

February 28, 2004

Recently, a finance officer at a Chevrolet dealer in Grand Prairie, Texas, signed a customer to a $46,911 loan over 96 months – or $18,136 over the invoice price of a Chevrolet Suburban.

The customer was upside down when she entered the dealership. That is, she owed thousands more on her trade-in than it was worth. Her new Suburban will keep her that way for years.

The deal was another in a rising tide of upside-down deals that is troubling the auto industry.

About 30 percent of all customers walk into showrooms upside down, according to one estimate.

That means the nation's multiyear string of strong auto sales is being propped up increasingly by longer loans and staggering consumer debt.

The debt level hasn't hurt new-vehicles sales yet. But rising interest rates could change that quickly, economists and auto finance executives warn.

Paul Taylor, chief economist for the National Automobile Dealers Association, predicts that soaring federal deficits will fuel a one percentage point rise in interest rates during each of the next two years.

When rates rise, monthly payments go up, disqualifying buyers with marginal credit.

Longer loan terms only make things worse. One prominent analyst says the average term has reached a record 63 months. The longer the loan, the longer it takes to build equity.

Some dealers are concerned, too.

"Being upside down is a killer right now," Frank Dellaquila, chairman of the Volvo dealer council, said at the NADA convention.

"Customers today are washed in negative equity, and it keeps getting worse. Plus, we're taking the customer out of the market for too long. It's just too easy to get under water today."

The problem is being compounded by hefty and enticing rebates; a trend toward smaller down payments; and the willingness of shoppers, dealers and lenders to roll over more debt into new-vehicle loans.

Edmunds.com, an auto-consumer Web site company in Santa Monica, says 30 percent of new-vehicle buyers nationwide were upside down in 2003, an increase from 24 percent in 2002.

To qualify for car loans, Edmunds.com says, buyers are rolling an average of $3,700 in old debt into their next purchase, a figure that has more than doubled since 2000.

At the same time, down payments have shrunk from 15 percent of the purchase price to less than 5 percent over the last decade, a record low, Edmunds.com says.

"Consumers are just delaying the time bomb for a couple of years," says Bob Kurilko, a vice president at Edmunds.com.

Hefty rebates contribute to the upside-down problem in two ways: They enable shoppers to buy vehicles that they otherwise couldn't afford. And they drive down the price of used vehicles, pushing owners further upside down.

The Power Information Network says a typical 2-year-old SUV immediately declines $500 in value for every $1,000 in incentives on the new model.

The Consumer Bankers Association says auto buyers on average now are financing more than the invoice price of their vehicles. In 1997, banks were lending 89 percent of a vehicle's invoice price to buyers. Last year that number hit 100.9 percent.

Alan Helfman, general manager at a Chrysler-Jeep dealership in Houston, says he does "easily a dozen" deals a month for customers who owe thousands more than what their vehicles are worth."

"I did one with a guy who was 10 grand upside down, but he wanted a PT Cruiser and got $4,250 on a rebate," Helfman says. "It's the only way he could afford it.

"There's no way I could put them in an expensive car if they weren't upside down (on the new car). They want a new car. They have an urgent need. What choice do you have?"

The customer, an artist in Houston, wanted to get into a new PT Cruiser when the warranty on his previous model ran out.

"I had a lot of miles on it and needed my monthly payments to stay the same," the artist says. "There's really no other way to do it."

Steve Girsky, an auto analyst with Morgan Stanley, told the Automotive News World Congress in January that the typical new-car loan now averages a record 63 months, up from 55 months in 2001.

More than 20 percent of all car buyers are choosing 72-month loans.

Girsky says that a one percentage point rise in interest rates would add $700 over the life of the typical new-vehicle loan. That might cause some buyers to rethink that next big purchase or 90-month term.

"Higher interest rates are the biggest risk out there for the industry," Girsky says.

Some dealers are starting to see the limits of long loans and rebates, but they say competitive pressures force them to keep the cycle going.

NADA Chairman Charley Smith says loans often run for 72 months or more, but that many buyers are enticed long before then by a continual flow of new products.

"The further they are upside down," he says, "the more difficult it is to get them financed and to add any products on top of that."

Mitch Connell, a Dodge dealer in Killeen, Texas, says:

"It's all about getting our numbers today, but it needs to be about tomorrow, too. It hurts the customer because it takes a long, long time to get out of negative equity, and it hurts the dealer because you still want to have that customer trade-in within three years."

But he adds that competition among dealers is feeding the trend of negative equity.

"As long as one guy is doing it, in order to compete I have to do it, too," Connell says. "It's terrible for the consumer, but it would be unwise not to compete in the marketplace. And the consumer only cares about the deal you're going to give to him."

Connell says the customer has to make the first move to solve the problem.

"One day they'll get wise and say, 'Hey, they've got to start making cars that last 10 years, or I've got to buy (one) every three years at a higher payment," he says. "I see the problem getting worse in terms (of loans) getting longer."

Economist Taylor warned that interest rates are poised to start rising, pushed partly by rising federal budget deficits.

Troy Balderson, a Dodge dealer near Columbus, Ohio, knows the risk and says he isn't biting.

When he started in the business 22 years ago, the longest loan he saw was 24 months. Now he says his dealership won't be involved in loans longer than 72 months.

He's betting that passing up a few immediate sales will make good business sense in the long run.

"Dealers get a terrible reputation, and the car has no value," Balderson says. "The customer comes back in and you're trying to bail him out, and they are so far into negative equity you just keep tacking it on. We're not helping them out because they never get out of it."

http://www.signonsandiego.com/uniontrib/20040228/news_lz1d28bomb.html
 

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gawd - that sucks (paying $18k over what your car is worth!! :shock: ). I actually went upside down when I bought my passat, paid about $1500 over the price to cover my previous balance on the trade-in. Never again.

My current car will be paid off this month (soon as the tax rebate shows up :D ). Next time I buy a car (in about 6 to 12 months -- actually gonna be 100% debt free before buying) I'm walking in with a hefty down payment.

It is pretty stupid (and yes I've been there) to want a non-necessity so bad that we're willing to go so hopelessly far into debt to get it.
 

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I've been giving the receptionist in my office a hard time about this for a while. She had a Cavalier that had some minor mechanical problem and it was out of warranty (but still well upside down, since she bought that car with negative equity in the loan too) and didn't have the cash on hand to fix it so just asked them to give her another car no matter what it was as long as it didn't increase her payment. Now she's got a base model S-10 pickup with a 7 year loan. When explained to her how she was paying more over the term for her loan on the S-10 than I was for my Subaru, she said it didn't matter because she'd have a payment forever no matter what :crazy: She really didn't understand that the money she owed on the Cavalier didn't just disappear when they traded it.
 

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A lot of people just don't understand debt. That's for the future, not right now, so who cares?. The monthly payment is right now, and is all they can comprehend.

It's just like credit cards.
 

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Paul Taylor, chief economist for the National Automobile Dealers Association, predicts that soaring federal deficits will fuel a one percentage point rise in interest rates during each of the next two years.
Beware of rising interest rates, everyone's going to get stung to some degree.

I've heard new car radio ads here saying something like "trade-ins may incur negative equity." It's like a secret code that they hope the average consumer can't interpret....
 

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The secret in sucessful car buying anymore is larger down payments and shorter loan spands. Say you could afford a $400 dollar a month car payment. If, you want that sweeeeeet car at the dealer down the street, but with a small downpayment you are looking at $600 dollar a month car payments for 60 months, then you are asking for trouble. That 60 months takes you, most likely, out of your warenty spand. So now you are paying to the moon on a car that you may be also paying for repairs ontop of. However, if you save up for a bit on that nice car, put a large sum down and take the $400 payments over say 48 or 52 months, now you are much closer to your warrenty, not paying as much, and getting more equity in the car. Gotta use your head peoples (and your finacial advisors too)! :D
 

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I totally don't understand how people get into these situations. Steven and I have been so careful not to ever do this, to the point that both of our cars were paid in full within two years of ownership. The idea of rolling over a loan like that is just complete idiocy. I suppose I just hate debt.

I know people who have gotten underwater on houses through no fault of their own (market dips, etc), but cars are predictable - they always lose value!
 

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My anwer to this is a two-fold approach-
1) Never take more than a 4 year loan.
2) Always aim to keep a car ten years.

Sure, I'd love to be driving a 5 series BMW. But I can't make it fit my budget for Rule #1.

I think a major part of the problem is the unwillingness of people to buy within their budget. They deserve that more expensive car - never mind that they are willing to take a 6 or 7 year loan when they won't keep a car for more than 3 years. It's all :crazy: . And the dealers won't put the brakes on it, either.
 

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Yup, Altair is right, except I would disagree with #2. But that's a personal thing. But, if you are the type to trade cars every few years...might want to consider a lease. But of course, i prefur to have NO car payment....never have had one, hopefully never will...paying cash for a car is the way to go...but i know that's next to impossible for most people...
 

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Altair 4 said:
My anwer to this is a two-fold approach-
1) Never take more than a 4 year loan.
2) Always aim to keep a car ten years.
my version is similar:
1.) only borrow 10K for 3 years ($300/month-ish), if possible NOT from the dealer.

here's why: you really are ready to change cars after 2 years right? so 3 is make-able but 4 seems like forever! and by the time you get to $400/month you should just lease a Lexus or some other high-dollar vehicle. i mean really, $400 (or more) a month just to drive a Malibu (or whatever), yuck!

2.) pay the rest in cash

therefore

3.) adjust the make / model year / options / mileage parameters to match how much you can scratch together to cover #2.

having #1 locked up ahead of time makes "dealing" less fun for the dealer too (they can't adjust the down payment, interest rate or duration of the loan) and it makes it more fun for you at the end of 3 years when the car payments are done for awhile.
 

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here: you guys will love this story.

In 1987 (IIRC) VA passed a law saying they could send you letter and force you to provide proof of insurance at any time of the year. No biggie, except thatat the time, I owned an Alfa Romeo GTV 6 2.5, that needed brakes tires, rotors and some other stuff. The ins on this car was bear, and really I couldn't afford it, but man i love that car and wanted to keep it. finally as the deadline for the Insurance came up, I knew I wasn't gonna make it. I wass broke, and couldn't afford both the work on the car and the insurance.

So I went upside down, trading the Alfa for an 1987 Nissan Sentra. :cry: I lost my ass, but had to finance both the remaining Alfa loan and the sentra loan together. I think I drove off the lot owing $13,000 for the 10k sentra. In the long run, it let me get out from under the mess I had made, and gave me good reliable transportation, with the added bonus that I was in a car that wasn't likely to get me any more speeding tickets. :eek:h:

my story has a happy ending, in that I kept the Sentra for over six years and really didn't have any trouble with it, and my ins went down enough that on a monthly basis I actually had more cash flow.

So, I can understand the appeal, but man, what a mess. :crazy:
 

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I learned the hard way too. Now I know the importance of gap coverage. In October I was involved in an accident which totalled my 98 Acura CL. Well, the insurance reimbursed me the Blue book value wich happened to be $3000 less than what I owed on the car after buying it in June of the previous year without transferring any negative equity. As the matter of fact I put down about $1500. So now I have a Passat w/ gap coverage and a 5 year loan term. Trying to pay down the principle as fast as I can though and still have some money to mod :lol:.
 

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One of Ross Perot's adages was that (he says) he never bought anything he could not pay cash for.....

Simplistic? Yes, probably overly so, but it works. It falls flat when you try to follow the same rule on a house, but if applied in all other areas, you will be OK :thumbup:
 

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Holicow said:
One of Ross Perot's adages was that (he says) he never bought anything he could not pay cash for.....

Simplistic? Yes, probably overly so, but it works. It falls flat when you try to follow the same rule on a house, but if applied in all other areas, you will be OK :thumbup:
A wise maxim indeed. I do prefer to use my Discover card instead of actual cash, paying each month's Discover bill in full. That way, I get a cashback award (however paltry) and free use of Morgan Stanley's money for 21 days. :lol: It's increasingly difficult to find merchandisers offering "cash discounts" anymore, so this approach works for me. The dealership where I bought my Passat didn't accept Discover, so I had to use actual cash for that purchase.
 

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Gap coverage is a major rip off. I think you'd be better off putting the difference on a 5% credit card if the need arises. Its like any other kind of extended warranty or insurance.
 

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raneek said:
Holicow said:
One of Ross Perot's adages was that (he says) he never bought anything he could not pay cash for.....

Simplistic? Yes, probably overly so, but it works. It falls flat when you try to follow the same rule on a house, but if applied in all other areas, you will be OK :thumbup:
A wise maxim indeed. I do prefer to use my Discover card instead of actual cash, paying each month's Discover bill in full. That way, I get a cashback award (however paltry) and free use of Morgan Stanley's money for 21 days. :lol: It's increasingly difficult to find merchandisers offering "cash discounts" anymore, so this approach works for me. The dealership where I bought my Passat didn't accept Discover, so I had to use actual cash for that purchase.
Sage advice, I do the same thing - I use Discover and pay it off monthly. However - don't be late on it (and this may be common, I don't know, I've got other cards but have only used Discover for the last 15 years) but anyway, don't be late because they actually go back TWO months for accured interest which I think is lousy but has also taught me to pay promptly! ;)
 
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