Ok, I have a thought/question about financing a car. I have never done this and I was thinking about it for a little while.

I have heard the term being "upside down" in your financing, a.k.a. owing more than the car is worth. Most of the time I hear how horribly bad it is nad people make it sound like you're screwed fro life if you are upside down.

Here's my thought.

Say I want a Z and it is 33,000 dollars. Neglecting tax and license, I get a loan for 33,000 dollars and get the car. I am now upside down cause insurance says it's only worth 28,000. 1 Week later I total it. Insurance gives me 28,000 dollars. I give it to pay off loan. I still owe 5,000. Can I still take my time to pay that off? Or, do the loaners want all 33,000 right away? Say I pay it off over the next year at the APR I was given, say 4 percent. I am then out about another 250 bucks for interest. Say I'm wrong and it's like 500.

Altogether I am out 5,500 and don't have a car.

Now, say I get the same car, except this time I front 5,000 down payment. and get a 28,000 loan for the rest. I am now not upside down, as the insurance says it's worth 28,000 and I owe only 28,000. 1 week later I total it, get my 28,000 and close loan.

I am out 5000 and don't have a car.

Now, I, being that I just graduated from college, don't have money sittin' in the bank. I plan on getting a Z as soon as I get hired somewhere, which means I will have to get a loan for the full amount. Meaning I'll be upside down. Am I willing to live with the fact if I total it I will be out 500 bucks plus my 5000? Sure, because I could get the car say 4 months earlier than if I waited and saved 5000 to put down.

Is this wrong? Am I forgetting something? I am taking a risk, that, in my example, I am only out 5500 bucks, which is only 10% more than I would be out if I waited to purchase.

 

doesn't insurance cover replacement cost, not trade-in value? while this could still make you upside-down, I wouldn't think it could be $5000.

 

Oh, I don't think it mattered how much I owed. My point was, if I front the down payment, that money is gone right away. If I finance the "down payment" then I pay it off over time. The only thing bad I see is that I pay more in interest on the higher loan.

 

I think that some insurers will offer "gap" coverage, which will make up the difference if the car is totalled and worth less than you owe (upside down). I don't know anything about it, but it may be something else worth checking out...

 

You would have to roll the remaining balance into your replacement car's loan, and be even upside-downer. but then your $500 dollars more example would be correct.

 

I've heard of that too, but I still don't understand why it's so bad to be upside down.

I really don't plan to be upside down for long at all. I will hopefully get a decent job (aerospace engineer) and any extra money at the end of the month will go towards paying off the car for the first 6 months or so. (Figured out budget using average AE starting salary and living expensies I will have about 500-1000 extra at the end of the month)

 

The only way I'd buy gap insurance is if I had multiple personalities, and one of them was suicidal. I can't imagine the risk of totaling your car while it's upside down (maybe 1 in 10,000 chance?) could be worth the $500+ for the gap insurance (that's what the jerk at the dealership was trying to push it on me for).

 

If the car is gone, then you have no collateral to back up the loan, the finanace company would most likly call the loan. You would have to come up with the extra 5K. Anyone that has a loan on a car that doesn't have replacement value insurance is at risk of this very situation.

 

So, I'd have more interest on the larger loan. Say, I didn't get a replacement until I paid my first loan (the 5k I'd still owe) off. I'd be back to square one right? Will they let me do that? I have a 91 cororlla with 162k miles on it, I think it'd last another few months.

 

Ok, so they'd want the entire loan back right away huh? Including the 5k I wouldn't get from insurance? I mean, a 5k loan isn't that much. Heck, I could just put it on a credit card. Much higher rate, unless I opened a new one with 0% intro APR. hmmm.....

 

its not horribly bad to be upside down, but its just generally bad to own something that you havent paid for, yet its worth less than you owe. its a fact of life if you finance your car. you always start out upside down because the car depreciates such a huge amount the second you drive off the lot(unless your downpayment offsets this), and then you pay it down slightly faster than it depreciates(unless you have a super long term loan...) then depreciation slows down as the car gets older, and eventually your even, typicly in 2-3 years and it starts to reverse where your car is worth more than you owe

your loan amount just sorta gauges how much you owe, so youd hope that the item that the lein is against would cover that loan.

 

My personal rule of thumb is not to buy anything I can't afford to pay for all at once. Putting that aside for the sake of discussion, I think it wise to at least drop 20% into the downpayment. This would keep you (probably) rightside-up, as well as give you an understanding of your "saving power" at whatever salary level you start at. Good life lesson too... It took me 9 months at my current job to truly understand how much each month I could afford for a car, how much bills and other expenses add up, how much I could put away for retirement, etc. Just my $.02

EDIT: BTW, I STILL haven't bought my Z (and I've been looking since I joined this forum, over a year ago)...

 

Normally, I would agree about the "pay for all at once", but for something like a car or a house, that doesn't really work for most people. It would take me probably 3 years or more to save enough money to buy at once. I will need a car sooner than that, I do own the 91 corolla, but not sure how long she'd last.

Anyway, looks like I will be ordering a '04 anyway, so I will have time to save some money to put down. (probably not 20%) but enough for now.

 

I believe in the "pay up front" plan as much as possible.

(The following is just an opinion, not the "only way" or a flame)

When you finance a car you end up paying significantly more for it since you are paying interest. That happens on every car you finance over your life time. It's like you can never catch up. Leasing can be even worse since you don't end up with any equity at all in the end.

My first 3 cars were used fixer uppers (77 VW Rabbit, then a 78 Camaro, then a 1968 Camaro convertible). All three were cheap and easy to pay off. Since I was not making car payments, I started putting the equivalent payment amount in the bank. When I had enough cash I bought a new car for (mostly) cash. (Ok, I did finance a little bit of it of it).

Once you get on top of this scheme you end up making payments in to your own bank account instead of paying a loan and interest. Then when it is time to buy the next car you got the cash. All the time you are not paying interest. It can really add up. Not only are you not paying interest, you are EARNING interest.

It is a little tough starting out and it takes dicipline. It isn't for everyone. But once you got the equity built up it saves you a ton of dough.

The only thing I have a loan on is my house. There was just no way I could expect to have THAT much cash on hand. Also the mortgage interest rate is low and tax deductable so the cash is worth more to me in investments.

It break my heart to see young people buying way more car than they can easily afford. It is sort of like starting a race in a hole.

Just my $0.02

 

That exact thing happened to a friend of mine. He was WAY upside down on his car. (He financed 100% of it, then put a zillion miles on it). The car was stolen and he ended up owing thousands of dollars on a loan for a car he no longer had.

The problems piled up from there. Since he couldn't pay off the the remaining balance the loan showed up as a problem on his credit report. This made it harder to get his next car loan and he ended up with a higher interest rate. In the end he was paying for his new car AND still paying off the old loan balance. It sucked.

Scary stuff.

 

Your dealer will offer gap insurance. At least mine did. ITs cheap. I had them throw this package in on my car to close the deal. I have had 29 cars in my life, 10 of them were purchased new. I never worry about "upside down" The minute you drive off the dealer, you're already upside down 2 to 3 K unless you put 6K deposit with 6% or less APR. Then you'll come out even. But your still out of pocket 6K. Anyway you look at it, CAR IS NOT AN INVESTMENT!!!!
Its a personal preference and taste. If you CAn afford 30K+ car, then get it otherwise, stay with 2o to 25 K car... you'll be better off in the long run...

 

Gap Insurance is a good thing if you are financing. I am self employed and 'sold' my other car so I get to write off the yearly depreciation ,mileage,gas etc as a business expense on the Z, believe it or not. I love america!

 

All this discussion of insurance is certainly one aspect of the value vs. loan balance question, but you should look at it in a more general sense, like we lenders do:
If you finance your car at 100% or anything close to it, and lose you ability to pay, the lender can repossess the car or you can voluntarily turn it in. They will sell it and if they are not able to pay off the loan from the sale proceeds, you would have a deficiency balance. Yes, at that time, they can call the loan, but if you couldn't afford to make the payments, how would you pay a deficiency balance all at once?? Typically, they would set up a payment plan to pay off that balance and the loan is unsecured, unless you have other collateral to pledge.

As car prices increased and depreciation could easily outpace loan balances during the first 1-3 years, leases became more popular. Less up front investment- you get to drive the car- you can get a new car at the specified time of lease end. Now there can still be problems with this- you can drive too many miles and the penalty eats you up, you can trash the car or otherwise default on the lease. Most of the time, though, you turn in the car and the car company arranges for the next portion of the car's life!! Of course, you have nothing to show for your years of making payments and you are locked in to having a car payment forever under this option.

If you finance at 100% for 5 years, you will have positive net worth in the car by sometime in year 3 or 4 at the latest and a total residual value at the end of the loan. If you do well, the car lasts another 2-3 years and you bank the equivalent of those payments towards the next car (yeah, right!!!!!!)