Do you Have an Upside-Down Car Loan?

Late in the nineties many auto finance companies started to increase the maximum number of months they allowed consumers to finance new vehicles. A few decades ago, the maximum term for most lenders was 66 months. Previous to the recent economic down turn some lenders were even offering loan terms as long as 84 months.

Aside from the competitive nature of auto dealership financing, the primary reason banks continued to stretch out the car loan terms was because many Americans wanted to buy an expensive vehicle while still maintaining an affordable monthly payment. The net effect of lenders stretching out the term, and consumers buying vehicles they previously weren't able to afford became a national epidemic of consumers with negative equity; commonly referred to as being upside down, under water, or buried in your trade.

If you think about it, it makes perfect sense; A 84 month car loan is 7 years. The halfway point of the loan is three and a half years and this is usually the time frame that most of us keep a new car, somewhere between three and four years. At that time most of us prefer to trade out of the used car and into a new one.

He's a specific example of being upside down in your car loan:

Let's say that in 2006 I purchased a brand new loaded up Chevrolet Tahoe Z71 for $39,415. Since I have good credit and qualified for a zero down, sign and drive, purchase with 84 month financing at a 6.5% rate.

After adding 6% sales tax to the purchase price and $150 for state registration fees the amount I financed was $41,929.90.

Over the next four years I drove this vehicle, on average, 15,000 miles per year. In 2010 I decided to trade in my Tahoe with 60,000 miles on it. According to a standard amortization schedule my payoff after 48 months would be $20,314.92.

So how does the payoff compare the used car trade in value of my Tahoe? At the time of this post, the clean Blue Book and the NADA trade value of a 2006 Tahoe with 60,000 miles on it was around $18,250. When appraising used cars most used car managers estimate the costs of any repairs that will be needed to make the vehicle ready for the lot while keeping the total vehicle below the clean trade cost.

In my case the used car manager estimated that it would take $1,250 to bring my trade up to snuff and ready for resale. So I was offered $17,000 as a trade in value.

Since I still owe $20,314.92 on the vehicle, I am upside down in my trade by $3,315.

Although it's not recommended, people with good credit can qualify for an upside down car loan with no money and then roll the negative equity into a new loan. I would expect a higher car loan payment on the new vehicle then on the old one though.

If on the other hand, you have bad credit, you generally have to make up the amount that you're upside down with a cash down payment.