Car shoppers drown in debt By Shawn Langlois, MarketWatch Last Update: 8:03 PM ET April 28, 2005
How to avoid being caught 'upside down'
SAN FRANCISCO (MarketWatch) -- From homes to student loans to that must-have Gucci dog collar, suffocating under a mountain of debt has become an accepted part of living in America these days.
And it's getting to be a real problem for car buyers, who are busy measuring their own necks for what could turn out to be a painful financial noose.
According to a recent Kelley Blue Book study, six out of 10 new-car shoppers, in an effort to cope with mounting sticker prices, opt for a longer-term loan with lower payments instead of taking on a smaller debt overhang.
"Most people are looking at this problem very myopically. Get those payments down. Get those payments down. That's all they care about," said Jack Nerad, editorial director of the car pricing guide's Web site kbb.com.
That shortsightedness has given rise to consumers being caught "upside down," or owing more on a car than it's worth.
For example, if you owe $20,000 on a car that's only worth $15,000, you're considered to be $5,000 upside down and monthly payments can get ugly fast when it's time for a trade-in.
The study also found that about one-third of these buyers, ever willing to spend money they don't have, end up in this debt bind when they hit showrooms for their next purchase.
"This negative equity position means car buyers are eventually left with two unpalatable choices: they can stay in their current vehicle longer or they can add to their debt pile," Nerad said.
Of course, those bitten by the buying bug will almost invariably choose the latter, thereby adding to a potential debt snowball.
"People who roll debt into their next car loans put themselves into an unwise, expensive economic situation," said Phil Reed, editor of Edmunds.com. "They will be paying off cars they no longer own while also paying down the loan of their current cars."
Another headache for automakers
The trend could also cause issues for major automakers like Ford (F: news, chart, profile) and General Motors (GM: news, chart, profile) , two companies that need another problem like Detroit needs another Pinto.
"Just as an overreliance on low-cost, subsidized leases came back to slam manufacturers and financial institutions in the 1990s, so too could the move to increasingly longer loan terms in this decade," Nerad said.
For example, if one-third of all new-car buyers decide to keep their vehicles longer, the already-beleaguered new-car market will have to deal with yet another consumer exodus.
Then there's the second option. Shoppers could go ahead, buy the new car and add more debt to their load.
This would inevitably increase the number of defaults and bankruptcies, Nerad said, which would drag on one of the few areas of relief for automakers in recent years, financing divisions like GMAC and Ford Motor Credit.
Borrow wisely
What can car buyers do to avoid the fiscal pinch?
Reed suggests that you put at least 20% down on a new car, which, in theory, covers the first year of depreciation. That way, you can start building equity much earlier.
If that doesn't work and your desire for a new car persists, consider buying one that has enough cash on the hood to cover your negative equity position. Reed pointed to the Ford Explorer, for instance, and its $4,000 in incentives.
That would do the trick with the average amount of negative equity in these upside-down situations, which Edmunds.com pegged at $3,642 per vehicle in March.
Kelley's Nerad offered consumers the simplest of strategies: Be realistic about how long you plan on keeping your new car and find a loan term that at least matches that timeframe. In other words, if you plan on driving a car for five years, get a five-year, or shorter-term, loan.
Too many may wrongly assume that the absolute lowest monthly rate is always the best fiscal choice.
"Consumers just aren't concerned with what they don't know," Reed added. "People really need to figure out where they stand."
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