Car refinancing traps

My previous entry mentioned how refinancing has become very common lately. A growing and alarming trend is car refinancing.

Just like with their homes, consumers roll unsecured debt into their car. Banks have become very creative and some of them allow amortization periods of eight years!

As a rule of thumbs, all debt except mortgage should be paid within 5 years maximum. Beyond that, you will pay too much interest and likely suffer from debt fatigue. Debt fatigue is when you feel overwhelmed and are likely to incur more debt.

The main issue with car refinancing is that people pay more for a depreciating asset. Unlike a home, a vehicle starts losing value as soon as it leaves the dealership. The brunt of depreciation occurs within the first 5 years.

When refinancing, people end-up owing –and paying- more than the car is worth!

The same happens when trading-in vehicles. Let’s say you have a 4-year old car with $ 10 000 left to pay on it. You walk into a dealership and trade-in that car for a new one at $ 25 000.

The dealer takes your old car back for $ 5 000 and extends you a loan for $ 30 000. Do you see the problem? Not only you owe more than your new car is worth, but you are also still paying for a vehicle you don’t have anymore.

Obviously, it doesn’t make sense whatsoever. Yet people are only looking at the interest rate and the low monthly payment. They fail to look at the actual cost and value of the car.

Bottom line, car refinancing is a terrible idea. The Federal Government has recently expressed concerns over this trend, but to date has no intention of intervening.

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