Is a 72-Month Used Car Loan a Good Idea?

Broadly speaking, a 72-month used car loan is very risky. This stems from the fact that a used car's value will depreciate at an accelerated pace. You run the risk of being in an upside-down loan very quickly in this case. Upside-down car loans contain many risks to a borrower.

Upside-Down Auto Loan

"Upside-down auto loan" means you owe more on the car than its current value. For example, if you buy a used car with 50,000 miles on it for $12,500, it may be worth only $8,000 after another 20,000 miles. This rapid rate of depreciation picks up after 50,000 miles and accelerates even more after 100,000 miles. You placed a down payment of $5,000, so your total debt is about $11,500 if you received an APR of 5%. If you are making payments of $250 each month to cover interest and a part of the principal, you may have paid off only $3,000. You will have an additional $8,500 of debt left to pay, but the car is only worth $8,000.

Effect of Low Payments

The reason you are in the upside-down situation above is not because the car is used. It is a combination of the age of the car and the length of your loan. You are upside-down because you failed to pay enough of the loan back in a short period of time. Increasing your monthly payment to $300 a month will shorten your loan. If you did this, you would only owe $7,900 on the car after one year. You would have an asset that is worth more than you still owe, which is the ideal situation to avoid negative consequences.

Recourse Loans

Most auto loans are recourse loans. This means you will be charged for the difference in value of the car and the remaining debt you owe if the loan goes into default. In the same example as used above, imagine you defaulted on your loan after one year. The auto lender would repossess the car and liquidate it. The lender may secure a profit of about $7,500 on the car at best. This means you are still on the hook for the additional $1,000. You lost all equity in the car, and you will not gain any back after making the remaining loan payments.

Value of Sale

Even if you do not default on the loan, an upside-down car loan is highly risky if you choose to sell the car at any point during the loan. A 72-month loan will encompass 6 years of your life. Your needs may change during those 6 years, and you may want to sell the car in order to select a different option. If you owe more than the value of the car, you will not recover enough through the sale to pay off your loan in full. Instead, you will have to fork over additional cash to the lender, greatly reducing the ability for you to provide a substantial down payment on the new car you select.

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