A new car loses about 20% of its value the year you buy it. After that it loses roughly 15% a year. Your loan does not shrink that fast, especially at the start, when most of your payment is interest.
So for the first few years you owe more than the car would sell for. This is called negative equity. It only matters if something goes wrong, but when it does it matters a lot.
Sell the car, clear the loan, and you still owe money.
How long it lasts
Take a car costing 800,000, with 150,000 paid up front and the rest borrowed at 9%. The amounts work the same in any currency.
| Loan length | Gap closes at | Worst gap |
|---|---|---|
| 3 years | month 14 | 38,000 |
| 5 years | month 34 | 94,000 |
| 7 years | month 52 | 141,000 |
The longer the loan, the longer you are exposed and the bigger the worst point. A seven-year loan leaves you underwater for more than four years.
When this becomes a real problem
- The car is written off after a crash. Insurance pays what the car was worth, not what you owe. You pay the difference.
- The car is stolen. Same result.
- You need to sell early. A job change, a move, a family change. You have to bring cash to the sale.
- You want to trade up. The dealer rolls the gap into your next loan, and now the new car starts underwater too.
Two things that shorten it
Pay more up front. Going from 150,000 to 250,000 on the car above closes the gap about eight months sooner. Nothing else you can do has that much effect.
Keep the loan short. Stretching from five years to seven lowers the monthly payment by about 1,200. It also keeps you underwater for another eighteen months. If the seven-year payment is the only one you can afford, that usually tells you something about the car, not about the loan.