Lawyers always talk about “reading the fine print” in a contract. We’re all guilty of signing a document at some point in our lives, without fully reading it. With large purchases, such as vehicles, you need to be extra careful, especially due to a growing trend in “underwater” vehicle loans, as well as vehicle loans based on inflated income. These loans are generally offered to people with “subprime” credit scores; sound familiar? Back in the early 2000s, we saw home mortgages offered to people with “subprime” credit, contributing to the financial “crash” of 2008 in which thousands of people lost their homes to foreclosure. Read more to see why “reading the fine print” is not always enough to prevent financial mistakes.
This trend is now seeping into the auto financing industry, and this is an example of the “underwater” vehicle loan problem. Joe Jones walks into the dealership and wants to buy a new car-his old one has mechanical problems, and he can’t sell it for enough money to pay off the loan. He has a balance of $5,000.00 on his current vehicle, and no cash for a down-payment. No problem, says the salesperson-you can roll that debt into a loan for your new vehicle. The new vehicle costs $30,000.00, which is financed along with the $5,000.00 that Joe Jones owes on the old vehicle. When Joe Jones drives off the lot with the new vehicle (which automatically loses value because it is no longer “new”), he is “underwater”. If Joe Jones runs into issues with the “new” vehicle, and repeats the same process, he can end up owing far more than his next vehicle is worth. For a great article on the “underwater” vehicle financing trap, click here. https://www.wsj.com/articles/a-45-000-loan-for-a-27-000-ride-more-borrowers-are-going-underwater-on-car-loans-11573295400
The second disturbing trend in auto financing is one where the auto dealer (or the finance company) inflates the purchaser’s income. This happened in the 1980’s with mortgage loans-lots of inflated and falsified information on mortgage loan applications. At the end of the 1980’s, there was a financial crisis in which thousands of homeowners lost their homes to foreclosure. In the auto world this is how it works: Joe Jones walks into a dealership to purchase a vehicle. He owns his car outright, but it’s a real beater, and he needs one that is mechanically sound. There’s just one problem-Joe only works part-time and earns $1,000.00/month, and has no other income to support himself. Joe gets “fast-talked” into a loan on a $30,000.00 vehicle, for a term of 7 years. The payments are roughly $425.00/month, due to Joe’s subprime credit score. Joe doesn’t think he can afford it, but the sales manager wants to meet the end of the month sales goals, and tells Joe that if he can him approved, he must be in a position to afford it. The sales manager, without Joe’s knowledge, takes Joe’s completed loan application, and changes Joe’s income from $1,000.00/month to $7,000.00/month. “Miraculously”, the loan is approved; however, 2 months later, Joe is behind on his vehicle payments, and is facing repossession. This article contains real examples of this scam. https://www.wsj.com/articles/an-809-car-payment-a-660-income-how-dealers-make-the-math-work-11576924201
Reading the fine print may not work in either of these situations; but, common sense can. We know that Joe Jones should not have signed off on the financing, because he clearly couldn’t afford either vehicle. Of course, if we suffer from “shiny object syndrome”, (and we all have) it can be hard to resist driving that new car off the lot. Use common sense when making large purchases, such as a vehicle. Consider the full cost of your vehicle, and not just the monthly payment-registration, insurance, maintenance. And buyer beware-if you buy it, you own it. You can try to “undo it”, but it’s a tough battle to win. Let’s all use common sense to avoid being financial victims.