One of the craziest things about cars is that you can probably go to a dealership and spend less money today on an expensive car than you would on a cheaper one. If you’re the type of person who saves fastidiously and doesn’t mind saying no to fancy bells and whistles in the name of frugality, then you can log onto Craigslist, find a used car for around $5,000, and as long as it’s made by a brand with a reputation for reliability — think Hondas and Toyotas, plus box-shaped early-’90s Mercedes and Volvos — you can drive it basically forever. Unfortunately, and very weirdly, because of the way car loans are structured, you’ve basically got to pay cash for cars such as these in order to actually only spend five grand on one of them.
Broadly speaking, in order to get favorable terms on your car loan, lenders want you to buy a car with relatively low mileage (usually less than 100,000, but the lower the better) that’s relatively new (usually 10 years old at the oldest, but the newer the better). A car that’s older, or one that has a lot of miles — and depending on the lender, even a car that’s just cheap because it’s cheap — will tend to command a higher interest rate from your lender, effectively multiplying the price you’re paying for a car by a significant amount.
That only gets higher as you stretch your monthly payments out. If you find, say, a 2008 Toyota SUV with 150,000 miles and a purchase price of $10,000, you can buy it secure with the knowledge that it’ll probably last until 300,000 miles. If you make a thousand-dollar down payment on that car and are given a loan with a 15 percent interest rate that’s to be paid out over 36 months (the typical term for an older and/or high-mileage car, since the bank hopes you’ll pay the car off before it breaks down), you end up paying over $11,000 on what was a $9,000 loan; at a 48-month loan term, you end up paying a little over $12,000. So in order to actually spend $10,000 on a car that’s only worth $10,000, you’ve got to pay cash.
The same is true, of course, when it comes to buying a newer, more expensive car from a place like CarMax, its online analog Carvana, or an actual, brand-new vehicle from a new car dealer. But because newer year + lower miles = higher price but lower interest rate from a lender, there’s a ton of pressure forcing your price range higher and higher. The higher you’re willing to pay, the more likely that a bank out there wants to become your best friend. Interest rates drop, loan terms magically burst through their customary 60-month cap and extend to 72 or 84 months, and dealers will suddenly pooh-pooh the thought of you even offering an initial down payment.
There’s a huge chunk of American adults who, despite having some sort of steady (even relatively high!) income, lack even the savings that would allow them to buy our hypothetical $5,000 car outright. If you are one of these people, on a purely emotional level, walking into a dealership and then driving away in a lightly-used BMW with a purchase price of $25,000 after simply signing a piece of paper agreeing to give a bank $377 a month might be deeply appealing, even if you’re going to end up paying that $377 for the next six to eight years.
The problem lurking just slightly below the surface here is that if a person needs to get rid of their car before they’ve paid it off, there’s an incredibly good chance that they’re going to be screwed. If you owe less on a car loan than the actual car’s value, that’s great — that means that you could sell the car today, use the funds to pay off the remainder of your loan, and either pocket the difference or put it towards the purchase of a new vehicle. The trouble is, whoever lends you the money also knows this. And any cash you make from selling your car, they would see as money left on the table from your loan. This is why they’re going to shove a new car down your throat whenever they get the chance.
In order to explain all of this, let’s compare houses and cars, two things that are very different but are very similar when it comes to getting a bank to help you pay for them. Much like car loans, home loans include down payments, interest rates, and loan terms, all of which help determine the amount you have to pay on the house every month. Over time, however, the value of a house tends to go up. Your $200,000 house can quickly become a $350,000 house if you repaint it, spend $20,000 on structural, spend another few thousand replacing your carpets with hard flooring, and are lucky enough to live in an area with a seller-friendly housing market. If this happens, you can make a few years’ worth of payments, sell the house for its new $350,000 price, and you’ll probably be able to walk away with a nice profit in hand. If your dog pees all over the walls, thereby making the entire place smell weird, and then the housing market crashes, your $200,000 home might only be worth $150,000, suddenly putting you underwater. But still! When you buy a house, there’s a chance its value will go up, and there are things you can do to help improve your odds.
With cars, meanwhile, it’s all but guaranteed that the value of your car will fall over time. Try as you might to keep it running smoothly and looking as pristine as it was when you bought it, a car starts losing value the moment you drive it off the lot. Even the ostensible exceptions to this rule, such as collector favorites like the Nissan GT-R or the Jeep Wrangler, don’t gain in value and instead merely decline in value at a slower pace than most other vehicles. That means that if you buy a used car and take a loan based off of its current value with high number of monthly payments, you could spend years underwater, making payments at a rate that never seems to catch up with your car’s falling value.
While it might feel obvious to point out this issue of declining car values, the financial ramifications of never getting ahead on your used car payments — and to be clear, even a new car becomes a used car once you buy it — can be disastrous. Last Friday, the Wall Street Journal published a report exploring the realities of the one-third of car buyers who are forced to trade in their current vehicle to buy a new one despite being underwater on their loan. Given that many dealers earn most of their money from selling consumers car loans instead of the cars themselves, lenders have been incentivized to allow consumers to roll their negative equity on their current vehicle into the loan for their new one, creating what are effectively multi-car loans paid by people driving a single vehicle. This has created a cycle of high monthly payments and long loan terms that often end in the vehicle getting repossessed and sold to yet more dealers at auction for a discount.
If you’re a car buyer, all of this ain’t great. It’s not that consumers are irresponsible, it’s just that the deck is stacked against them, which is what happens when it’s more lucrative to sell loans than cars. After all, cars are assets that are literally designed to depreciate in value, and at least with a house, the price of your house actually has a shot at going up after you buy it.
Of course, this is a fantastic system if you’re a car dealer or a lender. You get to sell someone a loan on a car that they can’t afford, make some money while they’re paying for it, and if you’re a dealer, you might even get to buy that exact same car you already sold once and sell it again to someone else. For big car companies and banks, this is terrificbusiness. But for consumers, whose used BMWs will never be worth more tomorrow than it is today, it’s a raw deal that’s becoming unnervingly common.