When it’s time to make a deal on financing a new or used vehicle, you might get an offer of 100% financing from a lender. It’s critically important to understand what 100% financing represents, and how it can lead to some dangerous debt situations.
How 100% Financing Can Lead to Negative Equity
The best results for any auto loan rely on paying off that loan as quickly and easily as possible. However, many loan types that lenders offer today are inverting this principle and creating some dangers for the consumer. In other words, some loan types are not really made to be paid off quickly.
100% financing means that the borrower will not put any money down on a vehicle. It means that the entire amount of the vehicle purchase will be put into a payment plan, with corresponding interest rates. By contrast, a customer who puts money down will not pay interest on that amount, only on the financing amount.
In 100% financing, payment schedules tend to follow a longer timeline, and that debt does not get paid down as quickly, since there is more interest, and more of the initial debt payments go to pay interest over principle (the actual amount of the loan). What can happen is that the owner can end up owing much more on the loan than what the vehicle is worth. Some financial experts call this being underwater on a loan. When your vehicle has lost all its value, but you still owe money, you may be in what’s called an equity bankruptcy situation.
Dealing With Negative Equity in 100% Financing
Even if they have chosen a 100% financing deal for an auto loan, buyers still have some options for helping to thin out negative equity. One option is to resell the vehicle early and pay off the remaining balance in installments, while purchasing a less expensive vehicle for transportation needs.
Another additional option is in what some would call “equity refinance”. Also generally referred to as loan modification or refinancing. Refinancing a loan means that a different lender will take on your debt at reduced interest rates, and you will pay less over the course of the loan. Refinancing is sometimes a necessity for borrowers who can make their monthly payments, and want to push some of that payment into a longer schedule. Sometimes, refinancing can save borrowers money if a variable rate auto loan has been adjusted for its correspondence to the U.S. prime lending rate of interest. However, it’s important to note that refinancing will not generally take away a significant portion of debt for a household. In any kind of loan modification or refinancing, it’s also necessary to make sure that the company or lender you are talking to is on the same level. Some debt refinancing companies have a habit of taking customers money without providing significant debt relief.
The above can help individuals and households who are vulnerable to negative equity in a vehicle due to a 100% financing agreement.