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Negative equity and today’s auto market

Remember not all that long ago when you could snag a car loan for 4%? Or even 5%? If you’re waiting for those rates to return, please keep in mind the dangers of daydreaming at the wheel.

As of the last quarter of 2023, the interest rate for a 60-month new car loan from a commercial bank clocked in at 8.15%, according to the Federal Reserve. That’s the highest rate the Fed has recorded since at least 2006, and may explain why people are opting for even longer loans — which, though the rates are higher, often come with lower monthly payments. At 72 months, the new car loan interest rate was at 8.67% in Q4 2023, the Fed reports. (These numbers are simple unweighted averages of each banks’ most common rate.)

So if you finance a car but only make minimum monthly payments, you could soon find yourself dog paddling to keep up with interest charges. Or, not keep up. Remember that few high-ticket items depreciate in value as quickly as a car. While there's no predetermined rate for this, the insurer Progressive estimates that many new cars may lose up to 20% of their value the first year and an additional 15% more annually until the four- or five-year mark.

And as of December 2023, the average price for a new car was $48,759, according to data from Kelley Blue Book. Assuming a depreciation of 20%, that car will lose close to $10,000 value even if it sits in your driveway for a year, doing nothing.

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Hitting the brakes on that underwater car

It’s one thing to look at this vicious cycle of sinking debt as inevitable. In truth, many American consumers could save tens of thousands of dollars, numerous credit score dings and untold hours of stress simply by taking a “needs vs. wants” reality check.

There’s a reason the phrase “new car smell” has entered the cultural lexicon. It’s an alluring, even addictive prospect, to purchase a new or gently used vehicle. The market knows this. Car sales teams also know how tired you are of looking at your dud’s dented side panels day after day.

But falling in love with a car — any car — before going over your numbers from top to bottom first means you’ve turned a rational financial decision into an emotional one. Once you get a firm grasp on your budget, you may find you’re much better off holding on to your used vehicle, opting for public transit, tuning up your bike and/or opting for rideshare.

Otherwise, you could find yourself driving in circles – even if it’s in style – on the way to the poorhouse.

Bloomberg quotes Ivan Drury, director of insights at auto-market researcher Edmunds: “Unless American car shoppers break their habit of buying again too soon, we’ll see the negative equity tide continue to rise.”

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Lou Carlozo Freelance writer

Lou Carlozo is a freelance contributor to Moneywise.

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