Buying a New Car - Read this!

Of all the purchases we make automobiles are generally among the most expensive; because of the substantial cost associated with buying a car it is unlikely that any of us would have the cash to make the automobile purchase outright, it almost always requires automobile financing to complete the deal.

In 2009 an American bank study revealed that the average purchase price of a new car increased by $300 in the second quarter of the year, Raising the average cost of an automobile to $27,000. According to the study a typical American family would now need to set aside 22 weeks of median income to finance a new car. This is particularly bad timing in 2 ways – for an auto industry struggling to survive and for American consumers who income remains stagnant.

Though prices continue to change for the worse other aspects of automobile purchase have stayed the same at least when it comes to the buying process. Wise car buyers know that they still must factor in the yearly operating cost of the car they intend to purchase; that is the cost of gas, maintenance and car insurance. An element that is often overlooked however is one of the most significant financial considerations in actually owning the vehicle is depreciation. Cars lose value quickly regardless of how well you maintain it the value of a vehicle decreases by 20% the moment you drive it off the lot. Imaging spending $26,000 on a car and losing as much as $5,200 in value when you drive it home. Because of the rapid depreciation of automobiles individuals who finance their purchase routinely fine themselves upside down on the vehicle loan, this means that the owner owes more on the automobile than the vehicle is currently worth. In financial terms the owner maintains negative equity or negative ownership value.

Let us say you purchase a new car in 2008 for $25,000, you made a down payment of $2,000 toward the purchase and required financing for the additional $23,000. In 2010 which is two years later although you have taken great care of your car the vehicle is now worth $15,000, at the same time even though you have made 2 years worth of payments you still owe $18,000 on the loan. You owe $3,000 dollars more than the car is worth and that my friend is negative equity.

What can you do in this situation? Financial counselors offer a variety of advice. Some would say it is best to sell the automobile secure a personal loan for the difference and then repay the entire loan to your finance company. However, in our current economic climate this maybe easier said than done. Perhaps the easiest way to deal with negative equity is to simply keep making payments until positive ownership equity has been established. While it is true you can trade in your automobile for another the negative equity of your old car would be built into the price of the new one. Using the $3,000 negative equity figure from our last example let’s say you traded in your automobile for a new model. The price of the new model is $20,000, however because you are $3,000 upside down the total cost of the new car would be $23,000. Baring in mind that your new car will also depreciate by 20% you would now have $7,000 in negative equity on your new car. In this scenario you are creating a cycle of negative equity with each succeeding vehicle purchase.

We also have to pay attention to the notion of negative equity if the vehicle is stolen or destroyed – contrary to popular belief finance companies are not willing to write-off the difference between what you owe and the actual value of the vehicle if this happens. Therefore it is important to discuss Gap Insurance when purchasing a vehicle. Gap Insurance will pay the difference between the actual cash value of your vehicle and the current outstanding balance on your loan or lease if you experience such a loss. Let us say your automobile is value at $10,000 yet you owe $15,000; if you get into an accident that results in your vehicle being completely destroyed you would be reimbursed for current value-$10,000 only. In order to satisfy your obligation to your finance company you will need to pay them $15,000. Gap insurance will cover the $5,000 deficiency saving you any out of pocket expense.