Financial experts bemoan the “crisis” in student loan debt (over $1.2 trillion as of 2015) and the rising rates of credit card debt ($733 billion as of 2015) but no one seems to be talking about yet another debt bubble – the huge rise of auto loan debt.
In 2012, total auto loan debt in the United States passed $1 trillion. Currently, the average household owes over $27,000 to vehicle lenders. More problematic, many of these loans extend well beyond 3 or 4 years. According to Edmunds.com, as of 2014, over 60% of auto loans were for terms over 60 months, with nearly 20% of these loans using 72 to 84 month terms.
60 months, of course, equals 5 years. 72 months equals 6 years, and 84 months equals 7 years.
Why a Long Term Vehicle Loan Means Trouble
You may ask “why should I be concerned about signing a 60 or 72 month car loan if I can afford the payment?” The answer, in a word, is “depreciation.”
Cars and trucks are depreciating assets. This means that they go down in value with each day and each mile of wear and tear. When you sign off on a 5 year or longer loan, you won’t be break even on your loan for at least 3 years. All your payments through at least year 3 (and most likely longer) will be applied to interest only. And my experience has been that folks who pursue long term vehicle loans often have less than perfect credit such that their interest rates are 7%, 8% or even higher.
This means that if your vehicle breaks down, or if you want to replace your car or truck 3 or 4 years into the loan, you will have to come out of pocket to satisfy the loan. If your vehicle is totaled in a wreck before the break even point, you will have to come out of pocket to pay off the loan because insurance companies pay property damage settlement based on “low retail” value.
If the dealership offers to “roll your existing payment” into a new loan, you’ll end up paying even more, because the new loan will include the leftover finance costs from the original loan plus the unfavorable terms from the new loan.
In essence, a 5 year or longer car loan equals a long term rental, except that you bear all the risk of loss. In case I am not being clear, a 5 year or longer loan is a toxic loan, and almost never a good idea. Even 4 year loans are less than ideal.
How Can You Escape from Long Term Vehicle Loans
So, what can you do if you are stuck in a long term vehicle loan? Some credit unions will consider a refinance that would allow you to reduce the term down to 3 years but that assumes (a) you can handle a higher payment and (b) that your credit score has improved to allow for a lower interest rate.
Another option to consider is Chapter 13 bankruptcy. Chapter 13 includes an interesting concept called a “cram down” that applies to car and truck loans. If you took your loan out more than 2 ½ years ago (910 day), we can reduce your loan balance to the value of your vehicle. We may also be able to reduce that high interest rate to a rate closer to the prime rate (which is currently around 3.5%).
- Here’s an example: Tom owns a car worth $15,000, that he bought 3 years ago with a 72 month loan at 8% interest. His current balance is $21,093 and his monthly payment is $440. In Chapter 13, we can cram down the $21,093 balance to $15,000 and reduce the interest rate to 4.5%. Tom will end up paying around $235 per month to the lender within his Chapter 13.
Obviously every case will be different, but if you have a long term vehicle loan at a high interest rate that you signed more than 2 ½ years ago, Chapter 13 can most likely save you thousands of dollars.
All Debts Must be Included in Chapter 13
Like any other financial tool, Chapter 13 is not a “free lunch.” You should not enter into any form of bankruptcy before educating yourself about both the positives and negatives. You will have to pay a lawyer to analyze your income and expenses, debts and assets and to prepare a Chapter 13 filing.
Understand as well that when you file bankruptcy, you have to include (and modify) all of your debts. In many cases Chapter 13 can reduce your monthly expenses and reduce your total debt but Chapter 13 is not the right remedy for every person.
If you are stuck in a long term vehicle loan, however, it does make sense to find out whether a Chapter 13 cram down can help you. Susan Blum and I have been representing Atlanta area residents understand how personal bankruptcy works for over 25 years. We are happy to answer your questions – call us at 770-393-4985 or use the form on this page to reach us by email.