‘Tip of the negative equity iceberg’: A record number of Americans are grappling with $1,000 car payments and many drivers can't keep up — dodge these 2 loan mistakes to stay ahead

Late payments, repossessions are on the rise

Used car prices surged during the pandemic due to supply chain challenges, which forced buyers to take out bigger loans — with higher APRs — for their vehicles.

Despite the fact that car prices started to cool off by the end of 2022, a concerning trend of auto loan defaults and car repossessions has started to surface.

According to the latest data, vehicle loans are third largest debt category for U.S. consumers with Americans owing $1.52 trillion in auto loan debt.

The percentage of subprime auto borrowers who were at least 60 days late on their bills hit 5.67% in December, trumping 5.04% in January 2009 at the peak of the Great Recession, according to the credit rating agency Fitch Ratings.

Ally Financial (NYSE:ALLY), one of the largest providers of car financing in the U.S., said its percentage of car loans that were more than 60 days overdue rose to 0.89% in Q4 2022, up from 0.48% a year earlier.

And the problem extends beyond auto loans. Major banks and lenders are experiencing similar issues with credit card debt and mortgages, especially when it comes to millennial and Gen Z borrowers.

As a result, several key players — including Capital One Financial Corp (NYSE:COF). and American Express Co. (NYSE:AXP) — have tightened their lending standards and boosted their rainy day funds to cover potential loan losses.

Vehicle repossessions are also reportedly on the rise after a sharp drop at the start of the pandemic when Americans were boosted by stimulus checks and lenders were more willing to turn a blind eye to late payments.

“These repossessions are occurring on people who could afford that $500 or $600 a month payment two years ago, but now everything else in their life is more expensive,” said Ivan Drury, director of insights at Edmunds, in the January report from Edmunds.

If you're in the market for a car and you need to get an auto loan, you can save money by avoiding these two common mistakes.

Read more: Chances are good you're overpaying for home insurance. Here's how to spend less on peace of mind

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Beware of negative equity

If you owe more on your auto loan than your vehicle is worth — known as being “upside down” — then you have negative equity.

For example, if you have $15,000 left to pay on your auto loan and your car is now worth $10,000, that means you have negative equity of $5,000 that you still have to pay.

According to Edmunds, the average amount owed on upside-down loans in Q4 2022 was $5,341 compared to $4,141 in Q4 2021.

Dealing with negative equity will require some planning and will likely take a larger chunk out of your monthly budget. If you can’t pay off your old auto loan out of pocket, you’ll have to roll the negative equity over to your new loan. This increases your risk of defaulting as you’ll be dealing with the higher monthly cost of paying for two cars at once.

“As we shifted toward an environment with diminished used car values and rising interest rates over the past few months, consumers have become less insulated from those riskier loan decisions,” Drury added.

“We are only seeing the tip of the negative equity iceberg.”

Don’t go for the longest loan term

According to the car buying website Edmunds, the average annual percentage rate (APR) on new financed vehicles climbed to 6.5% in the fourth quarter (Q4) of 2022 compared to 5.7% in Q3 2022 and 4.1% in Q4 2021.

For loans on used cars, interest rates were even higher, hitting an average APR of 10% in Q4 2022 compared to 7.4% in Q4 2021.

The longer the loan term, the lower the monthly payments but the more interest you will end up paying.

As the costs of new and used cars have skyrocketed, more Americans are seeking loan terms above 60 months.

In fact, the average auto loan now sits at around 70 months, or closer to six years, according to Edmunds, which means people are financing their cars for longer even if it costs more down the line.

Aside from paying more interest on your loan, there are other setbacks to extending the term.

The older your car, the more likely you’ll have to spend money on repairs and maintenance in addition to your monthly loan payments.

You could also grow sick of your car during a long loan term, leaving you stuck with years of payments you’re loath to make or with negative equity that you’ll have to carry over if you want to buy another car.

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Don’t forget about auto insurance

When you’re shopping around for the best deal on a new car, spare a few minutes to find a better deal on auto insurance, too.

On average, Americans pay $1,553 a year on auto insurance. But if you haven’t cruised through your options lately, you could be overpaying by as much as $500 a year on this essential policy.

Your best chance to find savings on your auto insurance is to spend some time shopping around and comparing offers.

Typically, that might mean setting aside hours — or even a whole day — to call up different insurers just to provide them with your details to get an accurate quote.

But with today’s comparison sites, in as little as three minutes, you can find the best deals on auto insurance all in one place.