Cars Worth Less Than the Loans

The Washington Post Sunday - - Business - Michelle Sin­gle­tary

I get so frus­trated when I hear peo­ple try to jus­tify buy­ing an ex­pen­sive car they can’t re­ally af­ford by say­ing, “ Well, it’ll hold its value.”

The truth is, no ve­hi­cle holds its value un­less it’s a clas­sic or rare car.

That Mercedes- Benz E- Class you crave may de­pre­ci­ate at a slower an­nual rate than a Mer­cury Mon­terey, but both ve­hi­cles will lose sig­nif­i­cant value the sec­ond they leave the deal­er­ship.

“ De­pre­ci­a­tion of­ten is the great­est ex­pense in­curred by driv­ers dur­ing the first five years of ve­hi­cle own­er­ship,” says Robyn Eckard, a spokes­woman for Kelley Blue Book, a lead­ing provider of new- and used- ve­hi­cle in­for­ma­tion.

The av­er­age ve­hi­cle re­tains only about 35 per­cent of its orig­i­nal value af­ter a five- year own­er­ship pe­riod, mean­ing that a car bought new to­day for $ 20,000 will be worth $ 7,000 af­ter five years. By the way, a Mercedes E350 re­tains only 36 per­cent of its value af­ter five years, ac­cord­ing to Eckard. The Mer­cury Mon­terey fares worse, re­tain­ing only 21 per­cent.

Car val­u­a­tions mat­ter be­cause an in­creas­ing num­ber of con­sumers are “ up­side down” on

their auto loans, mean­ing they owe more than the car is worth. In the first quar­ter of 2007, 29 per­cent of con­sumers were up­side down on their ve­hi­cles, Kelley Blue Book re­ports. Ad­di­tion­ally, on av­er­age, peo­ple traded in cars on which they still owed more than $ 3,600. And what do many of th­ese buy­ers do with that loan bal­ance when they want an­other car?

They roll that neg­a­tive eq­uity — the $ 3,600 and of­ten much more — into yet an­other ve­hi­cle loan.

“ It is a pan­demic,” says Jack Nerad, ex­ec­u­tive mar­ket an­a­lyst for Kelley Blue Book.

It is also fi­nan­cial lu­nacy. And mak­ing mat­ters worse are risky lend­ing prac­tices sim­i­lar to what we’ve been see­ing in the mort­gage in­dus­try.

In­creased pres­sure on au­tomak­ers and deal­er­ships to sell ve­hi­cles over the past few years has led to more car loans be­ing made to riskier bor­row­ers. Auto deal­er­ships orig­i­nated $ 50 bil­lion in new- ve­hi­cle loans to subprime bor­row­ers last year, ac­cord­ing to re­tail data from the Power In­for­ma­tion Net­work ( PIN), a di­vi­sion of J. D. Power and As­so­ciates, a mar­ket­ing re­search firm.

To make the loans work for many of th­ese subprime bor­row­ers, who typ­i­cally have shaky credit, the lenders are of­fer­ing longer pay­ment pe­ri­ods. New car loans last­ing more than five years in 2006 ac­counted for nearly 55 per­cent of loan orig­i­na­tions, ac­cord­ing to the Con­sumer Bankers As­so­ci­a­tion.

Subprime ve­hi­cle buy­ers, those with credit scores be­low 650, have loans that last an av­er­age of 61 months, com­pared with 56 months for more cred­it­wor­thy con­sumers, PIN found. Higher- risk buy­ers also tend to make lower down pay­ments as a per­cent­age of the pur­chase price, pay­ing about 11.6 per­cent com­pared with 17.4 per­cent for other buy­ers.

The same fac­tors that are push­ing subprime home­own­ers into fore­clo­sure — ris­ing in­ter­est rates on credit cards and home loans — could cause subprime car own­ers to de­fault on their ve­hi­cle loans, said David McKay, se­nior di­rec­tor of auto fi­nance and in­sur­ance at J. D. Power.

Let’s say you push your bud­get and pur­chase that pricey car. Then some­thing changes — your in­come drops or your mort­gage in­creases. You can no longer af­ford the car. How­ever, be­cause you took out a long loan with lit­tle money down, you owe more on the car than it is worth. You end up putting your­self in a sit­u­a­tion that re­sults in neg­a­tive eq­uity.

To stop this mad­ness and avoid be­ing up­side down on your ve­hi­cle or rolling debt into an­other loan, there are at least two things you should do.

First, use a 48- month car loan as a bench­mark for af­ford­abil­ity. If you can’t han­dle the monthly pay­ments with a four- year loan, you prob­a­bly can’t af­ford the ve­hi­cle you’d like to buy. Keep­ing the loan to 48 months or less also re­duces the chance that you’ll be up­side down on your car should you need to trade it or sell it.

Next, you should re­search the re­sale value of the car you’re in­ter­ested in pur­chas­ing. This will help you see that get­ting a long loan on a par­tic­u­lar model could be trou­ble, es­pe­cially if you tend to trade in and out of cars. Kelley Blue Book now pro­vides a de­pre­ci­a­tion chart on its Web site ( www. kbb. com) that shows pro­jected re­sale val­ues for all new ve­hi­cles. On the Kelley Web site, as well as at www. ed­munds. com and www. con­sumer­re­ports. org, you can find lists of the best and worst ve­hi­cles for de­pre­ci­a­tion.

But even if the car you se­lect has a good re­sale rat­ing, it’s still a de­pre­ci­at­ing as­set. What I’m ask­ing is that you change your think­ing about what a car is worth. And I’m not quib­bling over se­man­tics. There is a sub­stan­tial dif­fer­ence be­tween as­sets that have the po­ten­tial to ap­pre­ci­ate or that truly hold their value vs. those that de­pre­ci­ate year af­ter year. Your goal should be to put more of your money in ap­pre­ci­at­ing as­sets. K On the air: Michelle Sin­gle­tary dis­cusses per­sonal fi­nance Tues­days on NPR’s “ Day to Day” pro­gram and on­line at www. npr. org. K By mail: Read­ers can write to her at The Wash­ing­ton Post, 1150 15th St. NW, Wash­ing­ton, D. C. 20071. K By e- mail: sin­gle­tarym@ wash­post. com.

Af­ter five years, a Mer­cury Mon­terey re­tains 21 per­cent of its value,

ac­cord­ing to Kelley Blue Book.

DAIM­LERCHRYSLER

Af­ter five years, a Mercedes E350

re­tains 36 per­cent of its value.

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