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How Not to Wind Up Underwater On Your Auto Loan

Being underwater or upside down on your auto loan is not a normal situation for any borrower. The global financial crisis should not also be blamed. As early as before filing your auto loan application, you can already take steps to avoid ending up in an upside-down auto loan.

1. Opt out of dealership financing.

Auto loans arranged by dealers usually carry interest rates higher than what banks or credit unions offer. This is because they get their compensation for arranging auto loans by adding two to three percentage points to the base interest rate given to them by lenders. The higher the interest rate, the more likely you’ll end up in an upside-down auto loan. Always check the rates offered by credit unions, banks and online lenders before walking into a dealership.

2. Analyze depreciation patterns.

All new cars lose much of their value once driven off the dealer’s lot. According to Edmunds, new cars lose more than 20 percent of their value on average in the first year of ownership. But there are certain makes and models that depreciate more. You have to watch out for these vehicles if you don’t want to be underwater on your auto loan. Another practical tip is to choose a vehicle with good resale value.

3. Put some money down.

The down payment can be a hefty amount to shell out. The ideal down payment is 20 percent of the total purchase price but people these days only make an average of 10 percent. In any case, it is always best to put some money down for a car. Skipping the down payment only makes it harder for you to pay off the auto loan.

4. Don’t get enticed by long loan terms.

Long loan terms have become popular these days because they make monthly payments more affordable. But they are actually deceptive. The longer you stay in debt, the more likely you’ll be upside down on your auto loan. Keep the loan term as short as possible. Don’t stay in debt for too long. Some debt advisers suggest matching the length of your auto loan with the time you plan to keep the car to avoid being underwater.

5. Consider leasing a car.

An auto loan is not always the best option to finance a car if cash is not available. If you plan to keep the car for less than five years, it’s best to lease it than borrow money for it. The latter would always carry an interest rate which makes your outstanding balance surge over time. In that case, it will be very difficult to make the monthly payments as interest accrues. By leasing a car, there’s no auto loan and no upside-down situation to worry about in the first place.

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