Cars Worth Less Than the Loans

I get so frustrated when I hear people try to justify buying an expensive car they can't really afford by saying, "Well, it'll hold its value."

The truth is, no vehicle holds its value unless it's a classic or rare car.

That Mercedes-Benz E-Class you crave may depreciate at a slower annual rate than a Mercury Monterey, but both vehicles will lose significant value the second they leave the dealership.

"Depreciation often is the greatest expense incurred by drivers during the first five years of vehicle ownership," says Robyn Eckard, a spokeswoman for Kelley Blue Book, a leading provider of new- and used-vehicle information.

The average vehicle retains only about 35 percent of its original value after a five-year ownership period, meaning that a car bought new today for $20,000 will be worth $7,000 after five years. By the way, a Mercedes E350 retains only 36 percent of its value after five years, according to Eckard. The Mercury Monterey fares worse, retaining only 21 percent.

Car valuations matter because an increasing number of consumers are "upside down" on their auto loans, meaning they owe more than the car is worth. In the first quarter of 2007, 29 percent of consumers were upside down on their vehicles, Kelley Blue Book reports. Additionally, on average, people traded in cars on which they still owed more than $3,600. And what do many of these buyers do with that loan balance when they want another car?

They roll that negative equity -- the $3,600 and often much more -- into yet another vehicle loan.

"It is a pandemic," says Jack Nerad, executive market analyst for Kelley Blue Book.

It is also financial lunacy. And making matters worse are risky lending practices similar to what we've been seeing in the mortgage industry.

Increased pressure on automakers and dealerships to sell vehicles over the past few years has led to more car loans being made to riskier borrowers. Auto dealerships originated $50 billion in new-vehicle loans to subprime borrowers last year, according to retail data from the Power Information Network (PIN), a division of J.D. Power and Associates, a marketing research firm.

To make the loans work for many of these subprime borrowers, who typically have shaky credit, the lenders are offering longer payment periods. New car loans lasting more than five years in 2006 accounted for nearly 55 percent of loan originations, according to the Consumer Bankers Association.

Subprime vehicle buyers, those with credit scores below 650, have loans that last an average of 61 months, compared with 56 months for more creditworthy consumers, PIN found. Higher-risk buyers also tend to make lower down payments as a percentage of the purchase price, paying about 11.6 percent compared with 17.4 percent for other buyers.