When you owe more on your car than it’s worth at trade in time, you are considered “upside down.” A new report from Edmunds.com finds that auto dealers are seeing more buyers these days who are in this condition.
The big reason for this is that people are choosing extremely long financing terms in an effort to keep payments affordable.
With the average transaction price for a new car at almost $35k these days, there’s a real need to keep payments down.
Low interest rates, and factory incentives, often provide buyers with tantalizing options for buying expensive cars for low monthly payments.
The catch is that these buyer must extend the payment terms out to 72 months – or more – just to keep the payments reasonable.
This produces a situation where the car depreciates much, much faster than the loan is being paid off. Buyers who try to trade in after the typical 3-4 years find that they still owe a lot more than the car is worth.
Use the “20/20/40” Rule to Avoid Being Upside-Down
The way to avoid being in this situation is to buy right. This means looking at the big picture – not just the payment – and using the “20/20/40” rule.
This rule stipulates that a car is affordable when a buyer can make a down payment of at least 20%, use financing lasting no longer than four years — with principal, interest and insurance not exceeding 10% of a household’s gross income.
Applying this rule can be a rude awakening for many people. Many find that they cannot actually afford the premium, $30k-plus vehicles that have become so common in middle class driveways.
But by sticking within these guidelines, buyers can ensure that they not only have affordable payments, but they wind up with positive equity in the vehicle at trade-in time.