Why your short-term compact car is ‘upside down’ at time of trade in

We’ve all been there: 3 years or so into the ownership of a not so old car that may be looking a bit tattered around the edges. Or, that no-cure-itch sets in to “buy,” as every auto brand in North America dusts off those “low to no interest” factory incentive.

No payment for 90 days, take some cash for the holidays -- all nice enticements to buy now at that seemingly “too good to pass up” end of the year clearance sales. Hey, I love the smell of a new car, don’t you?

Low to no down, low interest and higher than market trade in value

No problem: Most car salespeople with the cooperation of a well sourced and funded sales manager, will bend over backwards to send you out the door with your new vehicle of choice. 2013 through 2015 were near record recovery sales years for the U.S. auto market. With record sales comes a pending used car trade in glut -- with an overall downtrend in 2016 new car sales -- the perfect combination for that “upside down” trade in.

Yes, there’s an exception or two, but overall, according to auto finance sector bellwether Black Book, the compact used car market is in the dumpster, with year over year resale value down-trending 22.8%. *Oct 2016

Here’s where things get a little dicey, and in general, an upside down auto loan (car’s worth less than what’s owed on it) is the end result of a long-term very slowly amortized auto loan.(if ever) And, although enabled and underwritten by the dealership’s partnership lender, falls squarely on the shoulders of the buyer -- it’s that “buyer’s remorse” thing, personified.

Getting back to negative trade in value and what we can do about it

It all begins with the initial purchase “deal” and our willingness to buy into a car or light truck with a price tag just a tad above our monthly income. “How much can you afford per month?” “What would you pay for the car if I could put you in it today?” “ It’s only another $75 per month, you can handle that!” “ Refinance the purchase through your credit union after the purchase.” We’ve all bought into the deal at one time or another.

The truth of the matter is: The only way the dealership automotive sales model works in today’s tight factory resale margarine, consumer price-educated world is “buy cheap, sell high” -- this is specific to your trade in value. So…

Most major brand non-premium cars and trucks retain no less than 45% residual resale value over 5 years -- go LONG on your new car or light truck purchase -- thus building a down payment base for your next new ride.

Avoid ZERO down, deferred monthly payment incentives. Remember that “no free lunch” thing. While finance managers can and do apply factory cash incentives to your down payment structure, if you’re trading in a used car, dollar for dollar, that incentive is more often than not “adjusted” off the wholesale value of your trade in -- resulting in a below wholesale purchase credit, if any.

Any deferred monthly payment will be added to the backside of your new loan, while the interest charge accrues -- impacting principal reduction -- while effectively increasing the interest rate.* Note: Not a bad guy, the finance manager makes his commission of the sale of your loan. That’s his incentive to make it work.

Now may be a great time to buy a lightly ‘used’ car. True enough, while dealership salespeople may convince you that in the long run (are you going long?) due to current factory incentives and yearly depreciation, buying new makes sense, but does it?

The average length of a car loan in the U.S. is 68 months

Most personal finance advisers tell us not to purchase a vehicle that can’t be paid off in 36 months or less. The reasoning is simple enough -- as is the interest structure of most auto loans -- the interest accrued against the remaining balance of the note is paid first. In the case of a 5 to 6 year auto loan, the “owed” or principle is not significantly reduced until year three. When that deficit is compounded by a declining used car market value, we’re screwed.

Dealer will roll the deficit into your new auto loan

Don’t do it! With today’s average new car price breaching the $30,000 mark, without a sizable down payment, most consumers can’t truly afford a new car purchase. But, often assuming that tomorrow will be financially brighter will buy one nonetheless. The enticements are compelling. In the end it’s up to the individual buyer to be shop-smart. Remember, It’s your signature on the bottom line. Hold out for the purchase or lease deal with terms that work for you; go long!