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."
That Mercedes-Benz E-Class you desire may depreciate at a slower annual rate than a Mercury Monterey, but both cars will lose significant value the second they leave the dealership.
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 these buyers do with that loan balance when they want another car?
To make the loans work for many of these subprime borrowers, who typically have shaky credit, the lenders are offering car loans with 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.
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 versus those that depreciate year after year. Your goal should be to put more of your money in appreciating assets.
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