GM has dug its own grave because it built too many cars in 2002 and 2003 and helped consumers finance them with 0% loans. This is causing the resale values of used GM cars and trucks to plunge. And because of the low resale values, consumers can’t trade in their old cars because they owe more on the loans than the car is worth. This is hurting demand for new cars. It’s a downward spiral for GM and the US consumer.
I don’t mean to pick on GM so much but I believe that its problems could have a negative impact on the entire US markets. GM’s debt is so huge that it will swamp the "junk" debt market if it declares bankruptcy. That will cut off financing for other "junk" rated companies and the resultant liquidity squeeze will ripple through the economy.
Many Buyers ‘Upside Down’ on Car Loans
Wednesday March 30, 5:53 pm ET
By Eileen Alt Powell, AP Business Writer
Growing Number of Car Buyers Find They Owe More on Car Loans Than Their Vehicles Are Worth
The phenomenon, known as being "’upside down" on a loan, is the result of a confluence of changes in the ways Americans buy and finance their vehicles.
To begin with, the prices of new cars and trucks have been held down as manufacturers offer incentives and rebates to lure purchasers. As new car prices flatten, so do resale values. Buyers, meanwhile, are choosing increasingly longer-term loans, sometimes extended over 84 months, to reduce monthly payments.
The result is that a consumer who trades in a car that isn’t fully paid for can end up wrapping the loan hangover into the financing for a new car, greatly increasing the cost. Or, if a car is destroyed in an accident before it’s paid off, the insurance settlement may not fully cover the outstanding loan.
The amounts consumers are upside down are substantial, experts say.
"More than a quarter of buyers are upside down when they come in, and the average is nearly $3,800," said Bob Kurilko, a vice president with Edmunds.com Inc., an auto information publishing company based in Santa Monica, Calif.
This loan overhang has implications for both trade-ins and insurance recovery, he pointed out.
Here’s the math: Say a consumer buys a $25,000 car and begins making payments of about $500 a month, based on a 6 percent interest rate. A tree blows over in a storm, flattening the vehicle. The insurance company agrees to pay, but values the car at just $22,000; the consumer is still on the hook to the finance company for $3,000 more, which must be paid out of pocket.
Scott Jones, 43, a New York free lance photographer, said he was aware of the risk of becoming upside down on a car loan when he went shopping for a new vehicle last spring.
"I read about it on some of the Web sites, and I tried to shop carefully to avoid that trap," Jones said. His strategy, he said, was "to buy a reliable car and pay it off as soon as possible."
Jones’ choice of a vehicle was a Honda Odyssey minivan, which he believes will hold its value better than some other vehicles. He made a cash down payment to reduce the size of his loan, and then financed the balance over six years, though he said he may try to pay it off earlier than that.
"I figure I’ll be driving it for at least 10 years — long after the loan is finished," Jones said.
Brian Reed, a vice president at Capital One Auto Finance, based in Plano, Texas, said a major contributor to the problem is that consumers have sought longer loans to hold down their monthly payments.
"In the late 1970s and early ’80s, most loans were for 36 months," Reed said. "Now, the average term is about 58 months, and some lenders go as long as 72 months or 84 months."
Consumers with long-term loans who trade their cars frequently will have built up less equity and be more likely to be upside down, he pointed out.
The best strategy, Reed said, is "to try to match the term of the loan to the time you intend to keep the vehicle."
Rob Gentile, director of automotive information products for Consumer Reports, based in Yonkers, N.Y., said consumers who know they’re upside down on loans often don’t bargain well for new cars, since they’re distracted by how that unpaid loan is going to be handled.
"Consumers should settle on the price (of a new car) before anything else," Gentile said.
Gentile also recommends consumers finish paying down a loan before they trade a vehicle, especially if it’s been a good, reliable car.
"If you roll what you owe into the new car loan, you’re financing the old car at the same time you’re financing the new car," he pointed out. "That will cost more in interest — and your monthly payment will have gone up, too."