I want to talk about cars and car loans. I have written a previous article on how and why to avoid car loans but this article talks a little more about it.

Today I have two vehicles, both made by Honda, and they are paid for with cash. I buy used cars, not new. And I only buy a car that I can pay cash for. If I only had $2500 to spend, I'd buy a $2500 car. If I had $1000 to spend, I'd buy a $1000 car. If I had $2000 to spend, I might even buy two $1000 cars so one would run at all times.

I've been in stages of my life where I didn't have the money to buy gas to get home. And I've had a car repossessed twice. Once by the lender. Once by an employer who had given me the car to drive and took it back after I quit. Can't blame them in either situation.

In former days I used to lease my cars. Now I think leasing is mainly stupid. I think the time to lease is when you have a huge amount of cash and just need a business write-off. The tax law favors leasing expensive cars because it limits deductions you can take if you buy the expensive car.

But most people lease or buy using a car loan because they want to drive more car than they can afford. And they look at the other debt slaves driving cars that *they* can't afford and want to be like them. It's human nature.

So now I think paying for a car loan is stupid for most folks and if you are in a situation where you owe more than your car is worth, this may interest you.

How the bank soaks you in a car lease

When the bank writes a lease, they calculate the residual value, based upon a guide called the Auto Leasing Guide. They also typically take out insurance from a third party who guarantees the bank against the vehicle being worth less than the RV. Sort of like private mortgage insurance but for cars instead of mortgages.

Let's assume a vehicle costs $25,000 and you do a 60 month lease, and the residual value is going to be $8000 at the end of 60 months.

If you turn the vehicle in (as I used to do all the time at the end of the leases on my cars) the bank auctions it at a huge auto auction. If the bank gets less than the residual value, the bank makes a claim to the insurance company who insured the residual value. The insurance company (nothing to do with your auto insurance, this is a company that insures the bank not you) then cuts a check to the bank for the loss.

But let's say you trade in a vehicle instead. You trade it in before the end of the lease.

The dealer will pay you what he thinks the car or vehicle will sell for, less a fat profit margin. So you may end up with $3000 or $4000 in "negative equity". This is added on to a new loan and you now are upside down $3000 on a new vehicle.

This is the basically same for cars people purchase rather than lease. And it is possible to do a short sale on a car to get out from under.

Is a vehicle short sale possible for a car?

I was stupid when I had my cars repossessed. I should have called the car lender and told them I was going to do a short sale.

When you have a car repossessed, or when you turn it in before the end of the lease term, the lender is going to give you dirt for the car. You are not getting fair value. It's worse for a repo because the lender will make you pay the repo fees. And the car will be sold at auction.

Ever buy something at a car auction? All you get to do is look at the car and bid. You don't know who owned it or anything about it. A car auction is a great place to buy a car and a horrible one to sell a car. When buyers buy at a car auction, they do so keeping in mind that things could be wrong with the car. So they bid low.

If you turn a car back in to the dealer or the bank, or have a car repossessed, you are doing things wrong. What you should do is this. Sell the car to someone privately, using Craigslist. Tell them the lender has to approve. And then talk to the lender and tell them you have a buyer, you don't have the money to pay the full loan, and need to do a short sale.

The lender won't agree unless you are behind in your payments. If you are really behind they will repo the car. So you might want to do this when you are only a little behind, maybe 30 or 60 days.

The lender gets all the money, and your liability is reduced. In the example I used, instead of $5000 you get the full $8000 for the car, and the lender gets their loan paid back.

This is the smart way to handle a lease or car loan you can't afford anymore and where you are "upside down." It isn't as easy as letting the car get repossessed, or turning it in, but it makes a lot more financial sense. Sell the car yourself, get a retail deal and give the money to the bank.

As always, they may come after you for the deficiency. But the deficiency will be far less than it would otherwise. And you can negotiate with them and pay this off. Meanwhile, pay cash for your next car.

I'd love to hear your comments about your car lease or loan experiences. And remember, I'm just some Guy on the Internet so don't listen to me. Get real advice and follow what you think is right.

Turn tragedy into opportunity. Learn how to do short sales for your clients and for yourself.

Please watch this video on short sales and foreclosures. This is a screen shot — just type in your email and I'll get you to the real video. It's geared to homeowners and Realtors who want to know everything they can about short sales. And it is the tip the iceberg…

 

 

photo CC license by http://www.flickr.com/photos/williamhook/ and http://www.flickr.com/photos/speakeasyx/