If you listed life’s best moments, driving away from the dealer’s in a shiny, fully-warranted vehicle would have to be up there.
But down the line, when it’s time to trade in or sell your car, the experience can be rather unpleasant. Your next car is sure to cost more than the old one, and you may still owe more on the old car than you’ll get for trading it in.
Nearly everyone who takes out an auto loan is in this “underwater” condition at the start, as vehicles lose value very fast in the first couple of years, while the loan balance shrinks comparatively slowly.
But if the loan and car-ownership period are well matched, the loan should be paid off by the time you sell the vehicle, or at least paid down enough that the balance can be covered by the proceeds from selling the car.
Obviously, the easiest way to ensure this can happen is to keep the car until after the loan is paid off. From a purely financial perspective, the best strategy is to keep each vehicle for as long as possible. Car depreciation is rapid in the first few years, then slows. So the more frequently you buy a new car, the more you’ll suffer this initially steep loss in value.
But let’s face it, a new car every few years is important to many drivers.
To avoid an underwater situation, borrow as little as possible. Do that by making a big down payment and resisting the temptation to roll fees and taxes into the loan.
Imagine you bought a $30,000 car, paying another $1,850 in taxes and fees. With a five-year, 5% loan for $31,850, you’d pay $601 per month, according to the BankingMyWay Auto Loan Calculator. After three years, you’d still owe about $13,700, nearly half the purchase price.
You might get that much or more on a sale or turn-in, but you might not. If you’d come up with $6,850 when you bought the car, and borrowed $25,000, you’d owe just $10,754 after three years, improving the chances of selling for enough to cover the loan balance. In addition, your monthly payment would be $472, not $601, saving $4,644 during 36 months.