Upside Down.
It was the early 1980’s. Ronald Regan was our 40th president of the United States and Americans were experiencing high inflation, interest rates, and unemployment. However by 1983-1984, the misery index was receding due to the improving economy.
During this period, I was in my twenties and spent seven years managing new car dealerships. Every fall as the new model year was being introduced and dealers were busy receiving new inventory, the public who had purchased the previous year’s model would return to the dealership, expecting to trade up one year while being able to keep their payments the same.
This is where I would often have to intervene at the request of the customer demanding me to explain why their car, only a year old with 15,000 miles, wasn’t worth any more than I was allowing. I was amazed by how few consumers really understood the components of the retail automobile transaction. In addition, the amount of household debt required to be serviced (due in part of an often impulsive emotionally irrevocable decision) had the potential to wreak havoc on the consumer’s financial well-being.
How many American’s each year purchase new cars with payments of $400, $500, $600 per month, only to experience some form of financial crisis and then discover their automobile isn’t close to being worth the value of what is owed to the bank? This is the reality of bring upside-down. Automobile loans will often exceed the value of the very automobiles they are secured by. There are many factors that influence the experience of being upside down or negative equity. Factors include the terms of the loan, interest rates, amount financed, depreciation, sales tax, mileage, color, equipment, age, and condition. It is very difficult to be in a position of positive equity on the purchase of a depreciating asset. This is especially true when 100%, no money down financing is leveraged.
When asked for advice on the purchase of an automobile, I begin by suggesting that we treat it as a subject of how to best manage our transportation expenses rather than thinking of it as an event. If you were required to deposit quarters into a meter installed on your car, how many quarters are you willing to deposit to drive one mile? With the cost of today’s new cars, it isn’t unreasonable to pay $500 per month. When the annual cost of fuel, registration, insurance, and maintenance is included, a person could easily spend over sixty cents a mile to drive around town. And if you drive 15,000 miles per year, the expense is $9,000 for just one automobile.
I suppose that if your household net after tax income is mid six figures per year and you are willing to allocate 5% or more of your income to cash flow some of Europe’s finest technology, then good for you. I will see you on track days. However if your household income is exponentially south of those numbers and you are allocating 20% to 30% of your net income to cover transportation expenses, you may want to rethink your approach. Unless, of course, you are one of those people who are busy living the upside-down dream of life.
