Negative Equity - A National
Disease |
By Donald Ladew |
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Capitalism has many benefits in a free society. It has inherent
benefits to those who are creative and willing to work hard.
Nowhere else can such a variety of people from many diverse
backgrounds and countries succeed by their own efforts.
However, sometimes our creative efforts cause serious problems.
As a people, we have become enamored of things, possessions, and
goods. We want to own the biggest house, the biggest automobile
and other possessions without number. And for all the things we
say we want, there are manufacturers ready and willing to
provide them. In order to be competitive these same
manufacturers are always seeking better ways to convince us that
it is possible to own that Cadillac El Mundo Gordo Magnifico SUV
when realistically we can only afford the Ford Sub-Midsized
ordinary Sedan. Desire for things, plus superb salesmanship
overcomes common sense and basic math. The result can be what
the subject of this article is all about.
Lets clear up a
couple definitions.
Equity: The market value of a
property (house or car or whatever) minus any mortgage or money
owing on the property.
Example # 1 Positive Equity: You
have owned a house for thirteen years. Its market value is
$400,000. You owe the bank $225,000 over the next seventeen
years. Your equity in the house is $175,000. This is positive
equity.
Example # 2 Negative Equity: You buy a house for
$300,000. The housing market changes and the market value drops
to $200,000. You owe the bank $225,000. Your equity in the house
is $25,000. This is negative equity and sometimes referred to as
being "upside down". This is a very bad thing.
Negative
Equity occurs frequently with automobile purchases. What do you
do if you've had the car two years and want to trade it in The
"upside down" buyer frequently adds the amount on the trade-in
onto the loan for the new car. They also stretch out the loan to
keep the payments low. This is a losing proposition as the
longer the loan, the longer it takes to reach a point where they
owe less than the vehicles depreciating value. It is a financial
Catch-22.
How does this happen?
It is a
combination of things. In order to sell more cars, manufacturers
offer deep discounts on new cars. This has the effect of
depressing the value of cars, which coupled with five and
six-year loans means it's going to take much longer for car
owners to achieve a position of positive equity. (two to three
years is not unusual)
It is a fact that the moment you
drive your car away from the lot it is a used car. If you are
paying $45,000, the Kelly Blue Book value may be $40,000. If you
still owe $43,000, there's a $3000 difference. How do you
protect yourself if you have an accident? Now the vehicle owner
has more problems.
Gap Insurance
Why is an auto
gap insurance policy so important? Because standard
comprehensive and collision auto policies only cover your new
car's "fair market value". And that can be as little as 80% of
what you paid for your car, starting the minute you drive it off
the lot. This condition of negative equity may exist for the
first two or three years of ownership.
This means that if
you're involved in an auto accident that leaves your new car
"totaled", you could end up paying off a loan on a car that you
can't drive. This is where gap insurance comes in. A gap car
insurance policy insures you for the difference between what you
owe on your car and what your insurance company says it's worth.
In some cases this insurance will be required as part of
purchase or lease.
Gap insurance coverage would also
become critical if your car is stolen. Thieves prefer new cars
and they seek out specific models, which usually happen to be
the most popular models of cars sold. (Honda Accord, Ford Taurus
- etc. etc.)
If your car is stolen, the insurance
situation is the same as in the case of an at-fault accident on
your part: comprehensive insurance will cover the value of the
vehicle, but not necessarily the value of the loan that you owe
to the bank. You could be stuck paying thousands for a car
that's long gone. Add that to the truly disheartening feeling of
having your car stolen, and that makes for a really rough time.
As a Lemon Law firm, we see many situations of negative equity
when a case is being settled with an auto manufacturer. Often it
is the first time the owner discovers the reality of being
upside down on their loan or lease. It is always painful. We
certainly could offer scads of advice about this situation. The
first piece of advice would be, never buy something that is
beyond your means. This advice will surely be ignored over and
over. The other thought, which isn't really advice is, if you
get caught in a situation where your negative equity is going to
be expensive, bite your lip and promise yourself you will never
get in that sort of situation again. It's bad for you and
accepting these kinds of deals only encourages manufacturers and
their financial organizations to offer these "good deals". |
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