I’m a huge proponent that you can’t get out of debt or follow a budget if you have budget busters. Typically these are too much house or too much cars. I don’t believe that cutting all the latte factors out, squeezing your grocery bill by $100 is the answer. If you have a $500 or $1k/month car payment, perhaps dropping that is the way to go. And a $500/month car payment can be easily achieved with a $20k car! So it’s not like a person is driving a BMW or Mercedes, it could be a Honda Accord or Toyota Camry!
But sometimes when you are dumping out of debt, a common suggestion is dump the monthly car payment. The problem everyone responds with is “I’m underwater” because I rolled negative equity into my loan. Or I overpaid. Something along those lines. Then the problem is compounded by the bad credit rating and inability to get a loan to cover the different plus a small amount for a beater car.
This problem was actually listed on a message board. GMC Yukon too expensive with the payment, insurance, and gas. But with rising gas prices the value kept dropping. What to do? They were underwater by $5k. Is it worth forgoing paying off the credit cards and focusing on the car instead? The monthly payment was $500, but they weren’t able to get a bank loan for the difference.
So should they focus on prepaying the car down? Try to balance transfer it to a credit card? The issue is that the $5k is already lost, but should they prepay it or wait until after the higher interest rate credit cards are paid off? But by getting rid of the car they can dump a monthly payment of $500!
Geez, I now realize why it’s a bad idea to buy a new car and keep getting car loans.
7 responses so far ↓
1 JoeP // Jun 8, 2009 at 9:31 am
Maybe I’m stuck on the terminology, but doesn’t “underwater” refer to owing more than the item is worth? Since cars depreciate over time, only those who financed a large amount of the car would likely fall into this condition, where someone financing a small amount would not (the car’s residual value would generally be greater than the loan payoff amount). But I have to wonder if it really matters, because you can just keep using the car as you pay…it’s not like you need to sell it.
I never liked car loans, because it is a loan on a depreciating item. The interest is a penalty for borrowing, and the actual value decreases so even the principal is artificially higher. We’re striving to save for our next car, and possibly tap our heloc if we come up short.
2 R. May // Jun 8, 2009 at 9:59 am
Yeah they can get rid of the car – but do they need one? Sounds like they made a poor decision on the vehicle – but if they need one then after they make find a way to come up with the 5k difference to unload it – they then have to go buy another one.
My instinct would be to focus on paying it off as fast as possible, maybe look into refinancing at a lower rate.
3 Meg // Jun 8, 2009 at 7:01 pm
If they plan on keeping it, they should pay of their highest interest first.
If somehow it makes sense to sell it, then they may need to save up some money to pay off the difference. However, I would think that it is rare that people save enough money on gas and monthly payments to justify taking a hit on a working vehicle and then going out and buying another car — even if it is used. They should DEFINITELY crunch the numbers on this one. My guess is that they’re better off keeping it and just trying to drive as little as possible to keep their gas usage down.
4 Michelle // Jun 8, 2009 at 8:23 pm
I’m of the opinion that if you are struggling to make that payment ($500), then dumping the underwater car for a beater is the way to go. I find it very hard to believe that someone who hasn’t been completely irresponsible in every other way (late late payments, maxed out cc’s, etc) can’t get a 4 or 5k signature loan at their local credit union…I’ve had credit scores as low as 525 (having been irresponsible in every other way) and got a signature loan for about that…Plus – what’s that person’s alternative? Continue to dig deeper in the hole? The Yukon isn’t going to miraculously regain lost value – they only have the option of paying off principle on the loan (get out from underwater) or selling. Retaining the vehicle shouldn’t be on the radar. I’ve been there, so I get to be a little judgy on the subject!
5 Kristy @ Master Your Card // Jun 9, 2009 at 12:16 am
It’s a tough place to be in, and without knowing the specifics, I’m not sure I can give the best answer. My first question would be ‘do they own a home?’ If they own a home and have some equity, it may be possible to tap that and help pay off the car loan and the credit cards, rolling everything into one secured loan.This would like free up quite a bit in cash flow for them, plus it would be easier to manage with just one monthly payment.
If that is absolutely not feasible, then I’d recommend finding some way to try and get rid of the Yukon in favor of a beater…at this point, the just need something that gets them from point A to point B and doesn’t cost them $500/month.
6 Rini // Jun 9, 2009 at 1:02 pm
The typical response to this issue is to work with the current lender. If a $20k car loan exists on a car worth $16k, then what the lender actually has is a $16k secured loan and a $4k unsecured loan, rolled together into one payment.
A smart lender would be willing to accept the $16k in cash (from the sale of the car) and convert the extra $4k into an unsecured personal loan. That’s all the value it has for them anyway!
Of course, smart lenders are regrettably difficult to come by, so the borrower will likely have to expend a good deal of time and effort to convince the lender to go to this “extra trouble”. Nevertheless, with some polite negotiation and a refusal to accept no as an answer, it should be possible. The bank does NOT want to repossess that car.
Also, the borrower will probably need to save the cash for a beater in advance, or else find a way to do without a car for a few months. (At $500 a month, it won’t take long to save enough for a beater once you unload what you have!)
The secondary option is to follow the advice above and find a small bank or credit union willing to lend you the $4k (in this example), plus another $2-3k to cover the cost of a beater.
7 LAL // Jun 10, 2009 at 3:21 pm
JoeP, sometimes people roll over their negative equity into another car loan when they buy a new car and thus why they end up with car loans worth more than the car is worth.
R.May, usually auto loans are lower than credit cards. The problem is dumping an auto loan can be difficult because you don’t own the title.
Meg, I think it depends on the cases. Sometimes people want to dump a car because $500/month payment is a lot.
Michelle, I think it’s just trying to figure out is it worth paying off CC because they are a higher interest than the car and smaller balances like Dave Ramsey suggests? Or focusing on a car so you can dump it without getting another loan?
Kristy, let’s make the assumption either renting or underwater on a house!
Rini, exactly the point with lenders. I know people who try to work with their lenders so they tell them to come take the car!
I think a big problem is having a bad credit score.
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