New rules may end some dealers’ practice of rolling old balance into new car loan

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People who owe more on a car than it is worth should think twice about trading in the car and rolling the old loan balance into a new one. It can be a costly decision.

“Ninety-nine times out of 100, you’re better off keeping the car you’ve got than buying a new one, because a car is a lousy investment, especially if you’re in a ‘negative equity’ situation, because you have to pay your way up to break even,” said Jack Nerad, author of
The Complete Idiot’s Guide to Buying or Leasing a Car.

Hold on a while

Consumer experts urge people to stick out the old loan until it’s paid off or, at the very least, until the amount they owe is roughly equal to the car’s market value.

In addition, negative equity financing may not be allowed in every state. Lenders have been trying to sort out state laws since new federal disclosure rules put negative-equity financing in the spotlight.

The rules went into effect Oct. 1 and require auto dealers to clearly spell out the financing for car buyers who are financially buried in their trade-ins.

Negative-equity financing may be an option for people who owe more than the car is worth.

“At least 30 percent of cars traded in have a negative equity balance of some amount,” said David Robertson, executive director of the Association of Finance and Insurance Professionals.

Dealing with negatives

ay a person owes $14,000 on a car loan, but the trade-in allowance is only $12,000. They are “upside-down” by $2,000. Under the new rules, a space for negative equity appears on the new finance contract and $2,000 would be added to the finance amount of the new auto loan.

In the past, an auto dealer may have noted negative equity by putting an amount like “-$2,000” in the box marked “down payment.”

“The problem is, by definition and logically speaking, a down payment cannot be a negative number,” Robertson said.

Because many lenders refuse to finance negative equity, many dealers have hidden negative equity by adjusting the purchase price of the new car or the trade-in allowance for the old car.

Tom Hudson, a Washington attorney who publishes CARLAW, a legal update on auto-financing issues, said most state laws are unclear on whether lenders may finance an amount beyond the purchase price.

“There are no clear-cut answers in a number of states,” Hudson said. “The argument could be made that negative equity would be allowed in nearly every state.”

David Jones, vice president of plans at
General Motors Acceptance Corp., said GMAC is accepting negative-equity financing in 14 states: Alabama, Colorado, Idaho, Indiana, Iowa, New York, North Carolina, Oklahoma, South Carolina, Tennessee, Texas, West Virginia, Wisconsin and Wyoming.

GMAC may someday accept it in at least four more states whose laws appear to allow negative-equity financing. Ten other states prohibit the practice, Jones said. The rest of the states fall into what he calls a “gray area.”

“That’s our view of it,” Jones said. “Each lender has their own view of it.”

Advice for

As the legal details are sorted out, what should people do if they are upside-down and longing for a new car? Consider making a big down payment to clear off the old loan or be prepared to stomach larger monthly payments if the outstanding amount owed on the old loan can be rolled into the new one.

“For a consumer, there’s just no magic to this,” Robertson said. “He has to pay off what he owes on an old car even if he buys a new one.”

How do people get caught upside-down? The reasons are numerous. First, all new cars depreciate rapidly in their first two years. Add in low- and no-down payment loans, long-term loans and low monthly payments and it’s no wonder so many people find themselves upside down two years into a loan.

Robertson said today’s rolling economy and booming consumer confidence add to the trend. Someone gets a big raise at work and suddenly the car in the driveway just won’t do.

Run over by debt

But it’s a costly choice, especially if the consumer gets in the habit of rolling over auto debt.

“It’s like building up any debt: It snowballs,” said Nerad, who also co-hosts the radio show
America on the Road. “The amount of money it takes to pay off the debt gets huge.”

The best way to avoid getting caught upside-down is to finance a car with the biggest down payment and shortest loan period possible.

“Bottom line is, whether you are leasing or buying, if you can’t afford to put 20 percent down, you can’t afford the loan,” said Mark Eskeldson, an auto expert and author of, a consumer information and advocacy Web site.

And one last tip: Don’t be afraid to haggle over the price of that dream car.

“You can always get a better deal. It may be next week. You may have to go to another dealership,” Eskeldson said. “A car is a commodity. It’s like buying a TV.”