Understanding Auto Loans with Negative Equity
Not all potential car buyers understand the idea of negative equity, but for a good chance at successfully financing a vehicle, you should know what this means and how to avoid it.
How Negative Equity Works
Negative auto equity is when an auto loan value is greater than what the vehicle is actually worth. Some financial experts call this an “upside down car loan”. In a negative equity situation, a vehicle owner may not have a whole lot of options. When the vehicle depreciates, and the loan value stays high, the driver is paying a lot on something that's not worth much.
Why Negative Equity Happens
Just as in housing markets, where bubbles and extreme fluctuations in value demonstrate flaws in the system, an auto loan market can be vulnerable to a high default rate, and for many of the same reasons that housing markets suffer. For example, financial experts verified that in 2007, negative equity and auto loans hit a 13 year high. Most of the people who studied this phenomenon would agree that there are some specific causes for these problems with car loan finance.
The main cause of negative equity is simply consumers buying more than they can afford. A large contribution to this problem is lenders who, instead of educating buyers on the risks, actually encourage this over-purchasing with tricky agreements that start cheap and end up expensive later on. Some of these arrangements include 100% financing with higher interest rates, as well as 0% APR deals that include interest rate spikes or a balloon payment at the end of a loan term. Many consumers will not take the time to understand these products, and those who do may still be confused and misdirected by crafty lenders, particularly at a dealership, where financing gets “worked into a package”. Consumer advocates point to a lot of dishonest practices on the part of lenders, and a lot of apathy and financial ignorance on the part of borrowers.
What To Do About Negative Equity
Consumer education could go a long way towards fixing a pattern of negative equity and auto loans. Regulation would help stop lenders from offering “no money down” products that are almost certain to end in massive debt spirals. But a lot of the responsibility is on the individual car shopper to fully understand the agreements they are getting involved in and to value upfront payment over payments that are put off for another day. Most of us know that back-loading a payment for any large asset is not generally a smart thing to do, but particularly in car sales, buyers tend to get caught up in the glamour of their ability to “buy higher”, and may not fully consider what may happen down the road.
Even for those who are not financing a new or used vehicle, it's worth following the phenomena of negative equity in auto loans, as well as in the housing market. To really understand how consumer actions affect not just households and individuals, but the greater financial community. Although housing markets get a lot of attention, auto markets are also a great microcosm for the way Americans do business. The more you know, the more you can be empowered to make the right financial decisions.