Seventeen years ago it was not a problem but now many bad credit customers are facing the same negative equity issues as traditional car buyers.
Buy and pay here
Seventeen years ago when the forerunner of our company, Auto Credit Express, first started helping people buy a car with bad credit, there were only a few lenders willing to give people with credit issues a traditional type of car loan. By "traditional”, we are referring to a lender that reports to the three major credit reporting agencies (Equifax, Experian and TransUnion) and has monthly repayment terms via a traditional payment book or payment process (such as electronic debit).
Back then, it was more common for consumers with bad credit to buy cars from local “Tote the Note” used car dealers that had a buy here pay here "pay as you go" program. Under these programs, consumers visited the car dealer weekly to drop off their payment. In most cases, the "rent to own" vehicle they were financing was an older car with a book value of between $1,000 and $5,000.
It was a major step forward for consumers when national finance companies entered the subprime lending arena around 15 years ago. The first subprime finance lending programs had repayment terms of 24, 36, or 48 months. Rarely would a lender approve a bad credit car loan that required a 60 month repayment term. These shorter repayment terms allowed consumers to buy a better car than they could otherwise afford at a buy here pay here used car dealer. Based on our internal data, the average vehicle transaction price utilizing these terms was around $10,000.
Since that time, the special finance market has expanded. Today, many consumers have bad credit or know someone who has bad credit. With the increased demand for bad credit auto loan services, up until the spring of 2007, we observed an increase in the number of subprime lenders that were willing to lend money to people with bad credit - then came the credit crisis.
Lenders in trouble
With the credit market contracting, a decrease in the number of lenders means decreased competition. Less competition has resulted in less competitive programs (in terms of interest rates and down payment requirements) for consumers.
Today, people with bad credit are getting traditional type auto loans at higher rates and usually higher down payments (than two years ago), but with longer terms than ever before. On the surface, at least the longer term would seem to be a good thing for consumers. After all, it allows a person with bad credit to buy a newer car and stretch out the payments, thus making the monthly amount more affordable.
The problem this has created is that there are now many Americans who are stuck with a vehicle they no longer want or which doesn't suit their needs. They are “welded to the bumper”, so to speak, because they owe much more on the vehicle than it is worth. Here is a good example:
- A consumer with bad credit buys an inexpensive brand new car for $18,000.
- The car is purchased with no money down and financed it for 72 months at a 15% interest rate
- With state fees and sales tax the total amount financed is $19,500.
- 36 months later the car is worth ½ its original value, $9,000.
- 36 months later the consumer still owes $11,757.
To add insult to injury, the example above is actually a best case scenario and assumes that the car, 36 months later, is still in great shape. Often it is not and it's worth less than ½ its original value. As this clearly shows, consumers that follow this path would find themselves owing at least $2,700 more on their car than it is worth. This $2,700 is known as “negative equity.”
Negative equity options
If all the payments have been made on time, there is a chance that the loan can be refinanced for a shorter term and at a lower interest rate. In other words, if there are 36 months left, the loan can be restructured and refinanced for 24 months. This will bridge the Loan to Value (what is owed versus what the vehicle is worth) gap more quickly.
Often, however, a new car is needed because a change in lifestyle requires a different type of vehicle. If this is the case, the following advice may help:
- Avoid repeating the situation by putting as much money down as possible when you trade in your car.
- If you are able to afford a much higher payment, consider rolling the negative equity into a short term lease. You may have a higher payment, but at the end of the short term lease you can walk away with no negative equity.
- To lessen the loan to value gap, new cars with large rebates work well. You can often find these cars during model year change over (late summer). Late model used cars that are out of season may also work well. A couple of examples would be a convertible in the winter time, or an off-lease car in high supply compared to demand (this is normally due to a high volume promotional lease event in the past).
If you have not made your current payments on time and still have bad credit you will have fewer options – the short term lease, in particular, will not be possible.
The Bottom Line
At Auto Credit Express, we helped a lot of people with negative equity and bad credit buy a new or newer car. We would, however, recommend that if you have negative equity, only trade your car in because you have to, not because you want to.
If you have any additional questions, please visit our web site at www.autocreditexpress.com. Our Resources section will help you determine how much car you can afford and, unlike other sites, our toll free number is listed on every page in case you have any additional questions.