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This is One Crappy Car Loan! Lessons on How NOT to Buy a Car!

By JLP | April 10, 2009

I received this email earlier today:

Hi!

I’ve been subscribing to AFM for quite some time now and I really appreciate almost all of your blog posts. My room mate just bought a car yesterday and because he has little to no credit (and may have been an easy target) got a 24.99% 6 year loan (his payments are around $380/month making the $13,000 car actually cost close to $30k!). He says he’s going to refinance in a year and hopefully will get a better interest rate after establishing more credit. The salesman said that he could pay extra towards the loan to pay it off early, etc. Let’s say he could afford to pay $480/month, would it be better to pay the extra $100 every month on this higher interest rate, or pay an extra $1200 once he gets on the lower interest rate? I hope my question makes sense! You always do a great job explaining things with your spreadsheets! :)

Thanks,

R

Your room mate made a really bad decision for a couple of reasons:

1. Running the numbers, I come up with a principal and interest payment of around $350 per month. R says his room mate is paying around $380 per month. This means that the sales guy either talked the room mate into buying insurance or he slipped it in under the radar. Regardless, it’s some expensive insurance that will cost him over $2,100 over the life of the loan. Your friend would be wise to go back into the dealership and DEMAND that they take the insurance off. UPDATE: It was a warranty.

2. He most likely will NOT be able to refinance his loan because the car will depreciate in value very quickly. It’s hard to refinance a loan on an asset that is worth less than what is owed on the loan. Due to the high interest rate on the loan, your friend will be upside down on this loan unless he pays substantially more towards the loan than his payment. That said, given how crappy the financing is, I wouldn’t be surprised to find that this loan has some sort of prepayment penalty.

Your friend would have been smart to have done some homework BEFORE he made such a commitment. It sounds like he made a decision with his heart and ignored his head.

Now, concerning your question:

Let’s say he could afford to pay $480/month, would it be better to pay the extra $100 every month on this higher interest rate, or pay an extra $1200 once he gets on the lower interest rate?

Here is a look at your friend’s car loan amortization summary:

Car Loan Amortization Summary

Assuming there’s no prepayment penalty, your friend would be wise to pay as much extra towards this loan as possible. I’m skeptical that he will be allowed to refinance this loan. I ran some numbers and found that if he paid an extra $100 per month towards the principal, he could pay the car off in less than 4 years, saving himself over $5,200 in interest.

I just hope that his decision hasn’t started him down the path of one bad decision after another. Usually people who get upside down on a car, stay that way for A LOOOOOONG time.

Topics: Basics, Budgeting, Financial Planning | 17 Comments »


17 Responses to “This is One Crappy Car Loan! Lessons on How NOT to Buy a Car!”

  1. Jordan Says:
    April 10th, 2009 at 3:35 pm

    The roommate might want to check if he can simply include extra payments on his bill, or if he must send all extra payments to a separate address. Many auto finance companies require payments towards principle mailed to a seperate address. They will treat extra payments in your regular bill as simply paying your next months bill early, and you won’t get the same benefit as if this money was going directly towards principle.

  2. Diasdiem Says:
    April 10th, 2009 at 3:36 pm

    24.9%??! Who the hell did the financing, American Express? Actually, depending on how good a rate he can get, wouldn’t it be better for him to pay off part of it with a credit card? That’s assuming he can get one, or if there’d be a large enough limit to make any real difference. Not likely if his rate with a lender is 24.9%. Unless they just saw this guy coming. He really made a mistake.

  3. Slava Says:
    April 10th, 2009 at 3:47 pm

    WOW! 24%????? How can anyone agree on that????

    This guy should pay as much as possible towards that loan to have it paid off sooner.

    I agree that it would not be possible to refi that loan

  4. Hogan Says:
    April 10th, 2009 at 10:38 pm

    Guess what every time a guy like this gets a crappy loan he drives up the cost of everything on people who are not willing to take such a huge risk. No more crappy loans, then guess what maybe the dealer would lower the price of the car to sell it.

  5. Eric Says:
    April 11th, 2009 at 4:42 pm

    Anyone heard of this company? I am look for a manager, any other companies would be appreciated.

    Managed Forex AccountsBellator offer clients institutional-caliber Forex money management.

  6. tom Says:
    April 12th, 2009 at 8:05 am

    Why didn’t he just get a used car for a few thousand?

    Can you even refinance a car? That is the first I hear of it. I mean even if the interest is lower, the car just lost more then 30% the following year.

  7. Bill Says:
    April 12th, 2009 at 10:04 am

    It is morons like this that helped get our economy in the state it is in now. When will people learn not to buy things they can’t afford. If you don’t make enough money to get a normal car loan, you better damn well buy a used car that you can actually afford. Also, what 13,000 dollar car does someone just have to have so badly as to take a loan like that? People need to stop being so stupid.

  8. kitty Says:
    April 12th, 2009 at 10:44 am

    “Guess what every time a guy like this gets a crappy loan he drives up the cost of everything on people who are not willing to take such a huge risk”

    Look on a bright side. He supports the economy, improves earnings of loan holder, car manufacturer, dealership, owner of the property that dealer occupies, even municipalities that collect taxes. So indirectly, he improves the value of our 401K. More guys like him, and we may actually be able to recoup our losses. Of course, this time we need to watch and get out before all of these people start defaulting again.

    24.99%???? I cannot believe it. Someone I know who also had no credit history bought a car some years ago and her interest was 13%. We all were telling her how high it was and how she shouldn’t have done it. But 24.99%?! Who is the lender?

    I am not against new cars – if you can afford it. But this person is not only broke, he is also young. Which means he is an inexperienced driver, not to mention someone whose insurance premiums are likely to be high. It’s just my opinion, but I’ve always thought young inexperienced drivers don’t mix well with new cars.

  9. kitty Says:
    April 12th, 2009 at 3:27 pm

    On a second thought 24.99% makes a lot of sense. He is young, has no money, and statistically very bad risk to crash his car soon. In total, the bank or dealership will not be able to recoup their losses. Or a year from now he may just not have money to pay. So in this environment they need these outrageous interest rate to justify risk.

  10. Hogan Says:
    April 12th, 2009 at 9:02 pm

    @kitty
    This loan is a mirage just like California real estate, hopefully we don’t bail out the bank after this guy defaults on his loan. Lower the price of the car then I will buy it, don’t give a fake loan to some guy who will never pay it back so you can get away with selling it at the price you want and expect the government to back up the risk you just took.

  11. kitty Says:
    April 12th, 2009 at 9:33 pm

    @Hogan – I was joking.

  12. kitty Says:
    April 12th, 2009 at 9:56 pm

    @Hogan: I was trying to joke, but out of curiosity I decided to look at the numbers from the lender’s perspective. Given how high the interest rate is, it doesn’t look that risky for the lender:

    After only the first year, he will have paid $4201. Let’s say he defaults or wrecks the car after one year – wrecking is better for the lender since the total value is higher than the resale value, so let’s say he defaults. The lender takes the car and sells. After a year, it’s probably lost 20% of its value if this is an American car, much less if it is Honda or Toyota. The original value was $13000, so 20% is $2600, so the lender can sell it for $10400. But by that time the bank has already received $4201 (from table above) i.e. the total amount the lender received from this guy is $10400+4201=$14601. So even with the default after the first year, the lender got $1601 in profit or 12% profit. So even if he defaults after just one year, the lender will have made a nice profit.

    The further he goes without defaulting the more money the lender will get. Also keep in mind that most depreciation occurs upfront.

    Now, the main risk is that he defaults sooner than a year. But psychologically the first year is kind of a “honeymoon period” when he is in love with his car, so more likely to make payments. Also, I’d imagine the lender got some nice fat fees upfront.

    Keep in mind that many of these subprime real estate loans were starting with ridiculously low rate upfront. So for the first few years there was no money for the lender. As soon as the rates went up – oops, default. This is different since the lender gets a lot of money very soon.

    A terrible deal for the borrower, a not-so-risky deal for the lender.

  13. Hogan Says:
    April 13th, 2009 at 9:06 pm

    @kitty
    You make some good points plus I am easy to bait on the whole bad loan debacle.

  14. Matt Hubbard Says:
    April 15th, 2009 at 7:53 am

    Return the car! You usually have 7 days according to state law to return a car, there may be a fee. PAY IT! It’s so much cheaper than that car loan.

    Tell your roommate to return the car.

    His interest rate is so bad it’s the same as putting the car on a visa.

  15. Matt Hubbard Says:
    April 15th, 2009 at 9:13 am

    Oh, and I think taking out a car loan longer than 2 years is foolish. If you can’t pay it off in two years you can’t afford the car. Especially when you consider that average car life is around 5.5 years.

  16. Libby | car loan Says:
    April 24th, 2009 at 11:12 am

    @kitty I agree with your statement “I am not against new cars – if you can afford it. But this person is not only broke, he is also young. Which means he is an inexperienced driver, not to mention someone whose insurance premiums are likely to be high. It’s just my opinion, but I’ve always thought young inexperienced drivers don’t mix well with new cars.” I think every first driver should get invest in a practical used car which they can afford to pay the insurance and payment without putting them under.

  17. Destini Imes Says:
    June 23rd, 2010 at 5:30 am

    Good post. The car insurance also depends on the cost of car. Some of the insurance company provides the cheap car insurance. I have gone through some of the sites where it provided the details of car insurance schemes or policies and benefits offered which will really suit car and it’s very useful too. carinsurancetemporary.co.uk

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