Millions Face A Motor Meltdown In Negative Equity, Expert Warns

Millions of Americans who financed their vehicles are on the brink of a financial meltdown, caught in the tightening grip of negative equity. Tyler Letson, an expert from Frisco CDJR, sounds the alarm on a growing crisis that threatens to ensnare countless car owners in a financial trap that’s hard to escape.

While negative equity isn’t new (as cars have always depreciated), many in the car industry worry that pandemic-related factors could have significant impacts on car owners who used loans to finance their purchases.

Mr. Letson explains how a combination of the pandemic, microchip shortages, and supply chain issues caused new-car inventory to plummet. A lack of supply for new and used cars pushed vehicle prices to record highs at a time when interest rates continued to climb, forcing many car buyers to make purchases at the top of the market. At the same time, government stimulus payments and work-from-home culture enabled many people to afford more than they could otherwise spend, resulting in much higher auto loan balances.

“The car market is now experiencing a period of reconciliation,” says Letson. “Consumers are finding themselves in negative equity situations that are hard to escape.”

This surge of challenges is particularly troubling for car owners who financed their vehicles with little or no down payment. The problem is exacerbated by the fact that cars, unlike houses, are depreciating assets. The moment you drive a new car off the lot, it begins to lose value, and this depreciation can quickly outpace the rate at which you’re paying down the loan.

“People don’t realize how quickly their car’s value can drop. Trade values are directly impacted as new car inventory levels balloon back up and manufacturers pump incentive dollars into the market in the form of huge rebates to maintain volume goals,” Letson notes. “It’s a cascade of setbacks that can leave you owing thousands more than your car is worth.”

Negative equity only becomes a significant issue when it’s time to trade in or sell your vehicle. If you owe more on your car loan than the car is worth, you’re faced with a difficult choice: either pay the difference out of pocket or roll the negative equity into a new loan, which often leads to an even deeper financial hole.

This situation is becoming increasingly common as the average length of car loans stretches to five, six, or even seven years. While longer loan terms might make monthly payments more manageable, they also increase the risk of falling into negative equity.

“Extending the loan term can seem like a good idea at first,” explains Letson. “However, the longer the loan, the greater the risk of being underwater on your car. We’re seeing a trend where even well-prepared buyers are caught off guard.”

Given these challenges, many experts are now advising consumers to consider leasing as a more viable option. Leasing, unlike traditional financing, allows you to drive a new car every few years without the long-term commitment of ownership. While leasing does come with its own set of considerations, it offers several advantages that can help mitigate the risks associated with negative equity.

“Leasing can be a much safer financial choice for many people,” explains Letson. “It allows you to avoid the pitfalls of long-term loans and the uncertainty of car depreciation.”

The leases our parents and grandparents cautioned us about no longer exist. There are several major advantages to leasing in today’s market, mainly mitigating risk for the consumer. The leasing company takes all of the risk when they establish a residual, which is essentially their best guess at what the vehicle will be worth in the future. Consumers then pay only for the first couple years of use, and then choose between three possible outcomes at the end of their lease:

1. Buy it out for the guaranteed residual that they established up front.
2. Trade it in for current market value (this works when there is positive equity just as if they had purchased the vehicle).
3. Turn it in and avoid any negative equity caused by unforeseen market shifts like we are in today.

“With leasing, you have a built-in exit strategy,” Letson points out. “You’re not locked into a situation where you owe more than your car is worth.” Leasing also typically involves lower monthly payments than financing a purchase, which can free up cash for other expenses or savings. Additionally, because lease terms are generally shorter – around two to three years – you can upgrade to a newer model more frequently, benefiting from the latest technology and safety features, all while maintaining manufacturer comprehensive warranty coverage which keeps your total cost of ownership down.

“Leasing keeps you in a newer, more reliable car,” says Letson. “And with the pace of technological advancements in the auto industry, that’s a significant advantage.”

The Case for Leasing Over Financing

For many consumers, the idea of owning a car is appealing, but the reality is that ownership comes with significant financial risks, especially in today’s unpredictable market. Leasing offers a way to enjoy the benefits of driving a new car without the long-term financial commitment and the risks associated with depreciation and negative equity.

“Car ownership isn’t what it used to be,” Letson reflects. “Leasing provides a flexible alternative that can save you money and reduce financial stress. However, it’s important to consider your individual needs and circumstances when deciding whether to lease or finance. Leasing may not be the best choice for everyone, particularly if you drive a lot of miles each year or prefer to keep your car for a long time. But for those who value flexibility and want to avoid the financial pitfalls of car ownership, leasing can be a smart alternative.”

“There’s no one-size-fits-all answer,” Letson acknowledges. “But for many people, leasing is a far better option in today’s market than taking on the risk of a long-term car loan.”

How Does a Lease Work With Negative Equity?

Leasing is a better option than financing for many drivers, but how does leasing a vehicle with negative equity work? If you’re already underwater on your automobile and you want to switch to leasing, you have two broad options:

• You can pay off the difference yourself and start a lease, wiping the slate clean.
• You can roll your negative equity into the lease agreement, allowing you to pay off the difference between your car’s worth and your loan over time.

It can be difficult to lease a car with negative equity because a dealer might not be willing to roll the entire amount into your new lease agreement. Your request may be denied if you’re significantly underwater, which presents a major risk to the dealership’s finances.

Is It Bad To Have Negative Equity on a Car?

Having negative equity in a vehicle is not a good thing – that said, it is not an insurmountable challenge. You can start leasing a vehicle with negative equity in order to break the cycle of depreciation, for example. Please visit the friendly Frisco CDJR team soon to learn more about managing negative equity.

Contact Our Expert Tyler Letson Today!