That’s not a good thing at all.
- Higher auto prices and borrowing costs have left many consumers underwater on their car loans.
- Many consumers are taking out longer auto loans to spread out their payments, but that’s not a great thing, either.
- Selling a car you can’t afford may not be an option if it’s not worth enough to pay off your loan.
It’s hardly a secret that car prices have been sky-high since the start of the pandemic. And not surprisingly, many consumers are on the hook for monthly car payments totaling $1,000 or more.
And it’s not just higher vehicle prices that are driving up auto loan balances. The Federal Reserve has been raising interest rates in an effort to slow the pace of inflation. As a result, it’s gotten more expensive to borrow money in just about every capacity, whether it’s a car loan, a personal loan, or a home equity loan.
But a new report from Bloomberg reveals that because auto loan balances are so high these days, more and more vehicle owners now owe more on their cars than what those vehicles are actually worth. And that’s a really big problem.
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An issue that could come to a head
Many people are familiar with being underwater on a mortgage loan — a scenario that arises when a home loan balance exceeds the value of that home. The same can hold true for car owners, in that it’s possible to owe more on an auto loan than what a car is worth.
This especially tends to happen when auto loans are paid off over a lengthy period of time, and when interest rates are high. That’s because borrowers accumulate interest on top of their principal, resulting in higher balances.
Meanwhile, according to Bloomberg, some dealers are noting an uptick in people wanting to trade in vehicles that are worth $10,000 less than their loan balances. And that’s a problem.
When you’re not underwater on your auto loan, and you start to struggle to keep up with your payments, you can sell your car and walk away clean. You can’t do that if the sale of your car won’t pay off your loan balance.
Be careful when financing a new car
If you need a car and have to finance it, be very careful in the process. You don’t want to end up in a situation where the value of your car is less than what you owe on an auto loan.
The average interest rate on auto loans for new cars rose to 6.9% in January, according to Edmunds. That’s up from 4.3% a year earlier.
If you have the ability to wait on buying a car, that could be a wise choice given how expensive auto loan rates are right now. But if you can’t delay that purchase long enough for both car prices and borrowing rates to come down, then at the very least, do your best to give your credit score a boost prior to filling out a loan application.
The stronger your credit score, the more likely you are to snag a competitive rate on a car loan — “competitive” being a relative term, of course. But a lower score could leave you paying a higher interest rate, and struggling with your monthly payments.
Also, if possible, aim to take out a car loan you can pay off in three years or less. Many people these days are taking out seven-year auto loans, but dragging your debt out for that long could mean spending a lot of money on interest in the course of paying off your car.