Stuck in drive

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MYRNA BROWN, HOST: Coming up next on The World and Everything in It: Drowning in Debt.

One in three U.S. drivers trading in for a new car is underwater on a car loan.

NICK EICHER, HOST: Underwater: meaning, the car owner owes the bank more than the vehicle is worth. But some people don’t realize that until it’s time to buy a new car and face the possibility of sinking even deeper into debt.

WORLD’s Lauren Smyth has the story.

LAUREN SMYTH: Noah Webster sells cars all day. But when he tried to sell his own car, he almost couldn’t close the deal.

WEBSTER: I go to sell the car… and had them do the appraisal, and [they’re] like, “Hey, you know, we can’t buy this car. It’s been in a major accident.” I was like, what?

Carfax had incorrectly listed a fender bender two years earlier as a major crash. That meant Webster’s car was worth a lot less than he thought—less than the loan he still had to pay off.

WEBSTER: And I kind of panicked, because it had been so long that I’d been trying to get rid of the car, and I kind of committed to it so much, but I couldn’t. And I felt like I was trapped.

Negative equity can happen in two ways: when a car depreciates, or when it’s totaled and insurance doesn’t cover the full value. The result either way is that the car’s value sinks below the loan repayment.

Speaking now as a car dealer, Webster says it’s common among young families, when parents want more seats or better safety features.

WEBSTER: When you’re growing a new family, you’re trying to be frugal. So that leads me to the reason why so many people will get negative equity, and that’s not putting money down.

Buyers who finance the full value of the car won’t have to pay cash on purchase day, but they’ll eventually have to pay off the loan and its interest. And that new car loses value the moment it’s driven off the lot. No money down means buyers will be underwater before they even get home.

On average, U.S. drivers now carry over $7,000 in negative equity, a record high. Webster sees it all the time with his customers:

WEBSTER: I’d say about 40 to 50% have a vehicle with negative equity—well, maybe a little less, maybe more like 30% have a vehicle with negative equity.

If the buyer doesn’t pay off the car before they trade it in, they’ll have to roll the negative equity into a new loan.

Is that a big deal? Well, it depends—on the buyer’s credit score, how much money they put down, how far they drive the new car, even what color it is. Webster says some of his customers find it overwhelming.

WEBSTER: People that don’t know they have negative equity—their only care is payment. As long as they can get approved and they can get the payment that fits them, they’re going to buy the car.

That choice may allow debt to compound until it reaches a breaking point.

WEBSTER: The vehicles that are going to depreciate the most in negative equity are going to be higher-end luxury vehicles and electric vehicles, and in this case it was both…. Unfortunately the owner of the car was flipped around $30,000 in negative equity. That is a monumental amount of negative equity.

That meant no loan and no car.

WEBSTER: We try to treat our clients as if they’re patients, right?—the same way a doctor would. So when a customer comes through the door, we're greeting them, we're sitting them down, we're going to figure out what their pain points are …

Some drivers find themselves with difficult decisions to make, needing a new car, but unable to finish paying off their old loan or to buy a used car with cash.

WEBSTER: The customer doesn't want their time wasted and or their hopes getting up going out looking at two different cars, test driving, finding the one you want, just to find out, oh, yeah, you can't actually even buy it.

If those customers have decent credit, they may still choose to buy a used car on a long-term contract. About 40% of car loans involving negative equity are now financed with seven-year loans, which cost the buyer more in interest but can be paid off in smaller increments.

And Webster’s own experience with negative equity? He finally managed to prove his car hadn’t been seriously wrecked. When it was re-appraised, the negative equity problem disappeared.

All told, he was underwater—or thought he was—for almost a year.

WEBSTER: I definitely have an advantage when it comes to understanding how this market works and navigating it, having worked in the industry for so long. But it can be very difficult, even with the knowledge and the know-how, because it’s always the same issue—that you don’t have enough money.

The average new car costs nearly $50,000, or nine months’ salary for the typical worker. For buyers who take out loans, that means the potential for more debt—and more risk that the debt will one day pull them under.

For WORLD, I’m Lauren Smyth.

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