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The Negative Equity Trap
[Spending Money You Don't Have]

Chinese immigrants called the United States the Golden Mountain. They did so because if you got here you could work hard and grow rich. You could buy land, build a house and you could rise or fall on your own willingness to work hard. The possibility that one could own something as valuable as property was extraordinary. It's the American Dream; own your own home, two cars in the garage. These things are symbols that the owner has the right stuff. But…in our desperation to have things mistakes were made, common sense ignored.

One cause of our current financial crisis is millions of people spending money they don't have. More accurately people are taking on debt they cannot service (keep making payments on). They get into this predicament by buying homes, over extending their credit cards, and purchasing new cars they cannot afford.

A few individuals, representatives of consumer protection groups, and independent financial journalists are speaking out about bad car loans and massive credit card debt, but their voices are drowned in the sea of noise that is the housing crisis. Rampant greed is not a pretty thing. There should be a warning engraved in stone on every street corner.


And don't go whining about how it's not your fault that those swindlers at the dealership, the evil loan officers at the bank or sleazy real estate salesmen made you do it. It is hard to imagine going through life blaming everything on the other guy, or the position of the stars, or the configuration of the leaves in the bottom of a tea cup. All games by definition have winners and losers. If you lost, it is important to take responsibility.

What can you do to insure that you don't lose your home or your new car? The answer is knowledge. The answer is to do your homework before you spend money you don't have. If you ask the government to bail you out, you are actually asking every other citizen who pays taxes in the United States—who have their own problems—to bail you out. It may come to that, but it isn't the best way.

If you say, "it's not my fault, the game was rigged!" Sure it was. It is the nature of business in a capitalist society to do everything possible to control the business environment. Does this mean that the rules are stretched, bent and twisted to gain an advantage? Sure it does. Remember the Savings and Loan banking crisis? That whole mess was about banking rules and regulations, or the lack thereof.

If you got caught in the Negative Equity Trap, in the language of the con man, you were the marks, the suckers. When the car salesmen sell you a vehicle you can't afford, they aren't going to go home and agonize over the rightness or wrongness of the deal. Jesus didn't kick the money lenders out of the temple because they were loitering!

There is a parasitic relationship between bankers wanting high interest loans and car salesmen doing what they do best, making deals. The fact that consumers suspend common sense and the simplest mathematical skills, plus the ability to see more than a week into the future and then replace common sense with blatant greed has been carefully analyzed and documented endlessly by financial pundits. The game got out of hand. The downward spiral, once underway carried so much weight it couldn't be stopped until it ran its course.

"Those who cannot remember history are condemned to repeat it."

I have heard this bit of wisdom attributed to Abraham Lincoln and others. It is so wise that it probably has been repeated since man had a sense of history. The point I want to make is, let's learn about negative equity on car loans so that we really understand it. With this in mind, the following graphs take a pictorial look at Negative Equity. Being upside down on a loan isn't rocket science. I've included an example of a very bad loan and a very good loan.

The loan example shown in figure 1 was intentionally made to show the worst kind of loan. Unfortunately many thousands of loans just like this one shown were made over the last 5 to 10 years. The lenders love them, the car dealerships love them, and regrettably the buyers do also. Consumers are able to buy big, expensive cars that were far beyond their means, often with disastrous results.

Figure 1. The Seven Year Car Loan With Negative Equity
The Three Year Loan With No Negative Equity

The loan in Figure 1 is an eighty-four (84) month loan. This is how the lender and the finance people at the dealership spring the negative equity trap. The yellow area tells you that if anything happens such that you have to sell the car or trade it in or have an accident, you are going to have to make up the difference between the red numbers and the blue numbers.

In the first year you are "upside down" to the tune of $21,939. If you total the car your insurance will only pay the current "Blue Book" value (the red numbers). That's why they sold you the GAP insurance, to cover the difference between the Blue Book value and what you owe on the vehicle at the time of the accident.

If you trade your car in for a newer model, I hope you didn't think that negative equity was going to go away. It's going to get added onto the amount you pay for the new car. If the new car was $50,000, the $21,939 will be added on and that will be the total you have to pay, or somewhere in that neighborhood. If you try to sell the car all you will get is the Blue Book value and in today's used car market, probably less. Figure 2 is the other side of the coin.

Figure 2. The Three Year Loan With No Negative Equity
The Three Year Loan With No Negative Equity

The loan shown in Figure 2 is an example of an excellent loan. This would be a car that holds its resale value well. A decent down payment was made and the consumer got his or her financing from a credit union or their bank. Even if something bad happens they will not be badly hurt financially. Remember, you have options. This is America. We have rules, regulations and laws. If predatory lending practices occur, there are consumer groups, regulatory agencies, government entities and attorneys who can dig into the matter. But before these options are used, you need the basic lessons of personal finance.


I really understand how cool it would be to drive a Cadillac Escalade. If you are making $35,000 a year there are lenders and salesmen who will find a way to get you into the Escalade, but in the end the price may be a lot more than $35,000. You could easily lose the car and have your credit ruined. Make the tougher decision. If you have a Ford Focus income buy a Ford Focus (good gas mileage also). When your income gets better, make a better deal and move up to a bigger car, if that's what you want.

Here are few essentials to making a good deal on a new car:
  • Get your own financing
  • If the salesman asks you what monthly payment you can afford, don't answer. Your financing and the length of the loan will determine the monthly payment.
  • Don't buy more car than you can afford
  • Don't sign up for a long loan to reduce your payments; that's a bank subsidy
  • Don't rush. If you get a dollar figure from the salesman, shop it around; find out if it's a good deal.
Negative equity is not good for you and when it becomes a national epidemic, as it has in the housing market, it's not good for the country. There is a direct connection between you and your family's survival and the survival of your country. Make the right decision and they will both do well.

By Donald P. Ladew Staff Writer
Norman Taylor & Associates
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