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Expensive borrowing habit

Alex says her financial situation was much better while she was gainfully employed. She earned roughly $2,000 a month working as a remote call center representative and had an auto loan at 13% interest with relatively manageable monthly payments of $430.

However, the situation changed when she got laid off. Alex was given $6,000 in severance but that wasn’t enough to cover all her expenses. She took out a $6,100 personal loan at 29% interest to cover rent and refinanced her car to borrow more, also at a 29% interest rate. She now has an outstanding auto loan balance of $21,560.

Now, she says her monthly auto payments are $692, and To make matters worse, the car she borrowed against is worth less than half her loan balance. Hammer estimates her 2017 Ford Fusion is worth no more than $8,734.

"You're upside down, dude, dramatically upside down in this car," he says.

Upside down car loans are not uncommon. In recent years, valuations of used cars have dipped while interest rates have climbed, pushing many borrowers into negative equity. Borrowers owed an average of $6,064 on upside down auto loans — a record high as of the fourth quarter of 2023, according to data published by Edmunds.

However, Alex’s interest rate is higher than that offered to borrowers with bad credit scores. According to Experian’s latest State of the Automotive Finance Market report, the average interest rate on used cars for deep subprime borrowers with credit scores between 300 and 500 was 21.55% at the end of 2023. But Alex seems to have signed up with a random loan offer she received in the mail rather than a regulated bank.

“Loan offers that come in the mail? Those are the most predatory loans ever, other than walking into a payday loan place,” Hammer explained.

Predatory lending practices among lenders who inflate rates have been gaining ground in the auto loan sector, according to Debt.org.

Hammer believes Alex could have avoided this unfortunate refinancing deal if she was willing to sacrifice some spending habits temporarily.

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Reluctance to compromise

After getting laid off, Alex says she struggled to hold down steady employment as she wasn’t pleased with the work culture at her next job. Hammer, however, insists she can’t be picky.

“We don’t take out 30% loans to survive because we were a little less happy at the job,” he said.

Finding another job and restarting her income should be possible given that “our unemployment is still close to record lows,” Hammer claimed. Indeed, the U.S. unemployment rate is at 3.8% as of March, which means Alex’s income problem should be solvable.

However, her spending problem is another challenge. Alex refuses to cut back on any spending, claiming she “wasn't living like a monk or minimalist.” Despite her predicament, she recently purchased an expensive espresso machine because she believes it was a good “investment.”

Sacrifice a little today for a better tomorrow

Alex acknowledges she made a mistake accepting those high-interest loans, despite feeling they were necessary at the time given her employment situation. But what she fails to understand is her situation was preventable. All she needed to do, as Hammer recommended, was a little financial belt-tightening.

Emergency fund” may as well have been the theme of the episode, given how many times Hammer muttered the term while going through Alex’s finances. It seems many of her debts could have been cleared immediately if she had enough discipline to keep three-to-six months' worth of expenses saved up. She might have also been able to make it through unemployment without accepting those high-interest loans.

Whatever your stance on buying a pricey coffee — or, in this case, a fancy espresso machine — to help get you through the day, common sense dictates taking care of the essentials first. Delaying gratification to ensure your financial security can be a game-changer.

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Vishesh Raisinghani Freelance Writer

Vishesh Raisinghani is a freelance contributor at MoneyWise. He has been writing about financial markets and economics since 2014 - having covered family offices, private equity, real estate, cryptocurrencies, and tech stocks over that period. His work has appeared in Seeking Alpha, Motley Fool Canada, Motley Fool UK, Mergers & Acquisitions, National Post, Financial Post, and Yahoo Canada.

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