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O’Connor: Don’t let underwater car loan sink budget

Brian J. O'Connor
Detroit News Finance Editor

Every once in a while a so-called “expert” shuts up and takes his own advice. And as amazing as that is all in itself — because the plumber’s toilet always runs and the CPA always needs to file a tax extension — what’s more incredible is when it actually works.

And, boy, am I glad it did.

While you and yours may have spent Thanksgiving Eve heading over the river and through the woods, I wasn’t headed to grandma’s house but to my neighborhood collision shop after getting rear-ended on the freeway. This capped a November just chock-full of nasty surprises, from our recent electoral unpleasantness to the fact that, while U.S. unemployment recently dropped again it soon could be rising for certain people to whom I’m extremely close.

So, while the bad news was that my recently acquired Ford Flex now is totaled, the good news is that unlike a lot of car owners, when the insurance company cuts the check I won’t still owe money to my credit union — though they probably won’t send me a calendar this year.

And they want the toaster back

According to new data from, 32 percent of new-car buyers who were trading in a vehicle owed an average of $4,832 on their old cars, while 25 percent of used-car buyers owed an average of $3,635 on their trade-ins. That’s a record, but it’s easy to understand when you look at two other figures: During October, the median U.S. household income was $57,616, according to the Auto Buyer’s Affordability Index. The average light vehicle sale: $31,076.

That means a household making more than half of all U.S. families would spend 54 percent of its pre-tax income to buy one new car. If they stuck to the standard advice to buy a car with total costs of no more than 10 percent of their pre-tax income, the most those families could afford would be $20,500.

Not to get technical, but if you’re doing the math at home, you know that’s a heckuva lot less than $31,076.

So how is it that annual new-car sales are on track to hit nearly 18 million vehicles in North America this year? Americans are putting less down, financing more and taking out longer loans, says Ivan Drury, a senior analyst with

“Monthly payments are something that’s so ingrained in everyone’s mind, that if they can just make it ‘affordable,’ whatever that means to them, they’re going to make it happen,” Drury says. “Buyers are being allowed to roll that negative equity into their new car loans, but it’s only affordable because interest rates are low and because they’re stretching out the payments.”

How long? Try six years or even longer. As of September, the average car loan runs 68.7 months — meaning it won’t be paid off until Halloween 2022.

Now THAT’s spooky!

The first thing you can do to avoid that fate is simple, says Stephen Pounds, a personal finance analyst with the consumer site Drive your car longer.

“The average car these days lasts at least 10 years now,” Pounds says. “When I was younger, if you could get six years out of car you were lucky.”

Buyers who don’t put a lot of miles on a car can consider leasing to keep monthly payments manageable, but make sure you can live with the total miles you’re allowed to drive. If your lease allows 12,000 miles a year, but you think you might end up traveling more than that, purchase extra mileage up front, when it’s cheaper than paying a penalty at the end of the lease.

If you’re buying, think used and affordable. My rule is to buy something you can pay off in 36 months. After that, bank what your monthly payment and drive that puppy ’til the fenders fall off. Even though I made only 11 payments on my 2011 Flex, I’ll get a check from my insurance company instead of writing one to my bank.

Another rule of thumb is the 20-4-10 rule: Put 20 percent down, finance for no more than 4 years and keep your total annual payments — principal, interest and insurance — to no more than 10 percent of your yearly pre-tax income.

To make that work, you’ll need to shop hard. Line up your best financing deal with a credit union or other local lender before you ask about dealer financing. Research your trade-in value and prices on what you’ll buy, and be sure to ask about incentives for students, retirees, veterans and anything else you can find.

If you’re short on savings, consider “gap insurance,” which covers the balance between what you owe and the car’s value. That way, if a meteor crushes your car as you drive off the lot, you’re covered. Your best bet may be to add that coverage to your auto insurance, where it can cost as little as $20 a month. Add that in to your total car costs when calculating how much car you can afford.

You may not be able to buy the latest, greatest or swankiest new car on the lot, but when it comes time to sell — especially if a minivan driver decides to park her car in your back seat — your finances won’t end up as roadkill.

(313) 222-2145

Twitter: @BrianOCTweet

Brian O’Connor is author of “The $1,000 Challenge: How One Family Slashed Its Budget Without Moving Under a Bridge or Living on Government Cheese.”