Are you under water on your current vehicle?
Important: A vehicle is rarely an “investment”. Unless you are into buying old cars that appreciate in value, the car you buy is simply transportation and not a part of your “investment portfolio”. This is because, in most cases, an automobile is an asset that depreciates rapidly and does not gain value over time. With the advent of longer-term loans, the likelihood that a car will depreciate faster than the amount being paid on principle is very high. That means that even if you’ve been paying for three-plus years on the loan, it’s quite possible that you will still owe more on the car than the car could be sold for in the open market… putting you in the position of being under water on your auto loan.
If you find that you owe more on your current vehicle loan than the vehicle is worth, to buy a new car you’ll need to cover the deficit with cash out of your pocket, or roll the old car’s loss into the new car’s loan. This adds to the overall cost of the new car and, effectively, makes the vehicle you’re buying more expensive.
Consider this simple example: Say you are buying a new car that will cost $25,000 and you can put down $5,000 cash. You want to add the value of your trade-in to try to reduce the cost. But you find out that you actually owe $10,000 on the old car and it’s only worth $5,000 in trade it. That means that you’re “under water” on the auto loan by $5,000. Because of that, the “value” of your trade-in is actually NEGATIVE $5,000. This is called negative equity. To make up for it, the negative $5,000 will be “rolled into” the new loan, effectively increasing the price of the new car your buying to $30,000! Clearly, that isn’t a good place to be.
Think, if over the next 10 years you did this three times, rolling $5,000 into a new vehicle each time. At the end of the ten years, you could find yourself having to roll in $15,000, $20,000, or even more into the next car you buy. Now that’s a serious problem that no one wants to have.