‘Tip of the negative equity iceberg’: A record number of Americans are grappling with $1,000 car payments and drivers can't keep pace — stay ahead by dodging these 2 loan mistakes

‘Tip of the negative equity iceberg’: A record number of Americans are grappling with $1,000 car payments and drivers can't keep pace — stay ahead by dodging these 2 loan mistakesWith a record 16% of American consumers paying at least $1,000 a month for their cars, it's no surprise that drivers are starting to fall behind on their bills.

The percentage of borrowers at least 60 days late on their car payments is higher today than it was during the peak of the Great Recession in 2009.

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There are multiple factors driving this trend. Car financing costs are climbing as the Federal Reserve continues its aggressive campaign of interest rate hikes to combat persistent inflation.

At the same time, used car values are dropping, leaving debtors at risk of owing more money than their cars are actually worth.

As your monthly car costs increase, you can dodge a debt default by avoiding two common auto loan mistakes.

Late payments, repossessions are on the riseUsed car prices surged during the pandemic due to supply chain challenges, which forced buyers to take out bigger loans — with higher APRs — for their vehicles.

Despite the fact that car prices started to cool off by the end of 2022, a concerning trend of auto loan defaults and car repossessions has started to surface.

The percentage of subprime auto borrowers who were at least 60 days late on their bills hit 5.67% in December, trumping 5.04% in January 2009 at the peak of the Great Recession, according to the credit rating agency Fitch Ratings.

Ally Financial (NYSE:ALLY), one of the largest providers of car financing in the U.S., said its percentage of car loans that were more than 60 days overdue rose to 0.89% in Q4 2022, up from 0.48% a year earlier.

Vehicle repossessions are also reportedly on the rise after a sharp drop at the start of the pandemic when Americans were boosted by stimulus checks and lenders were more willing to turn a blind eye to late payments.

“These repossessions are occurring on people who could afford that $500 or $600 a month payment two years ago, but now everything else in their life is more expensive,” said Ivan Drury, director of insights at Edmunds, in the January report from Edmunds.

There are ways to save money as the cost of car ownership grows more cumbersome.

For instance, you can take a look at your current auto insurance policy. If you have had the same one for a while, it might be time to shop around for a better rate to help bring those monthly bills down.

If you do choose to get an auto loan, here are two common mistakes to avoid.

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Beware of negative equityIf you owe more on your auto loan than your vehicle is worth — known as being “upside down” — then you have negative equity.

For example, if you have $15,000 left to pay on your auto loan and your car is now worth $10,000, that means you have negative equity of $5,000 that you still have to pay.

According to Edmunds, the average amount owed on upside-down loans in Q4 2022 was $5,341 compared to $4,141 in Q4 2021.

Dealing with negative equity will require some planning and will likely take a larger chunk out of your monthly budget. If you can’t pay off your old auto loan out of pocket, you’ll have to roll the negative equity over to your new loan. This increases your risk of defaulting as you’ll be dealing with the higher monthly cost of paying for two cars at once.

“As we shifted toward an environment with diminished used car values and rising interest rates over the past few months, consumers have become less insulated from those riskier loan decisions,” Drury added.

“We are only seeing the tip of the negative equity iceberg.”

Don’t go for the longest loan termAccording to the car buying website Edmunds, the average annual percentage rate (APR) on new financed vehicles climbed to 6.5% in the fourth quarter (Q4) of 2022 compared to 5.7% in Q3 2022 and 4.1% in Q4 2021.

For loans on used cars, interest rates were even higher, hitting an average APR of 10% in Q4 2022 compared to 7.4% in Q4 2021.

The longer the loan term, the lower the monthly payments but the more interest you will end up paying.

As the costs of new and used cars have skyrocketed, more Americans are seeking loan terms above 60 months, or five years.

In fact, the average auto loan now sits at around 70 months, or closer to six years, according to Edmunds, which means people are financing their cars for longer even if it costs more down the line.

Aside from paying more interest on your loan, there are other setbacks to extending the term.

The older your car, the more likely you’ll have to spend money on repairs and maintenance in addition to your monthly loan payments.

You could also grow sick of your car during a long loan term, leaving you stuck with years of payments you’re loath to make or with negative equity that you’ll have to carry over if you want to buy another car.

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This article provides information only and should not be construed as advice. It is provided without warranty of any kind.
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