Several car dealerships are offering deferred car payments for up to six months. Sounds like an opportunity for many to buy a new car or truck – right? Purchase a new car and no payments for six months.
How can anything go wrong or put anyone in a bad financial situation? Let’s take a look behind the scenes.
Auto sales are slumping from the coronavirus outbreak. According to Car and Driver magazine for March sales, GM had sales declines of 7%, Ford saw sales drop by 12.5%, Toyota and Hyundai had sales decline of a whopping 37% and 43% respectfully. That is a lot of new cars just sitting losing value to the manufacturers and the dealerships.
6 Months in Deferred Auto Payments
In an effort to move these vehicles, dealerships are offering several incentives to try and get us to purchase a new car. There is 0% financing, and also deferred payments for up to six months. Think about that: drive a new car and no payments for six months. That sounds like a great deal. Except…
..there are two problems. First, interest still accrues on those loans. For those with excellent FICO® scores, the interest rates are generally very low. For those with less than excellent FICO scores, such consumers can pay substantially higher interest rates and accrue much more interest during those first six months. This is where problems start for many consumers.
For example, a consumer elects to purchase a $25,000 car. He finances the purchase at a 7.99% interest rate because of an average FICO score of 680. (Those that have lower FICO scores face more challenges with deferred auto loan payments.) During the first six months, the loan accrues $998.75in interest that is added to the loan balance. The loan balance after six months is $25,998.75. The balance of the loan is going up, not declining.
Think of it a different angle. You are really purchasing the car for $25,998 -- not $25,000. Why would you pay more for the sales price of a car? We all don't want to do that. Why defer payments which really translates into a higher cost to purchase the vehicle.
The second issue is depreciating. If the car has depreciated $5,000 after the first six months, the future value of the vehicle is $20,000. So now the consumer owes $25,998 and the car value is $20,000. In this common situation, the consumer is stuck in the vehicle and is relegated to making payments. It would be more difficult to sell the vehicle unless the amount owed on the auto loan is paid above and beyond the value of the car. Such consumers are stuck with no real options to sell the car, or even possibly refinance the auto loan to a lower interest rate.
In this way, it is easy to become upside down into a car loan – something that happens all too often. When someone s upside down in an auto loan, any hiccup for such consumers can lead to late payments and possible repossession. A bad decision (such as a deferred auto loan payment program) followed by a financial hiccup such as a job loss, health issue or other unforeseen financial challenges is a common pathway to a personal financial crash.
What to Do?
The best advice is to not to agree to deferred payments unless one of two possibilities will occur. First, you put money down on the car for a lower loan amount and to avoid being upside down at the time of purchase. Second, if you are certain you will have the money to pay off the loan within a year or two, you could avoid this path. In either situation, you are protecting yourself financially..
Otherwise, deferring payments on a new auto loan is a financial recipe for disaster.