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When I was lining up at the grocery store today, I overheard these guys talking about trading up for a new car, because this pandemic is stifling car sales. Can you explain like I'm 5, in simplistic English? What do they mean?

New car prices are inflated an exorbitant amount, so that people can refinance the negative equity of their current vehicle back into the new one. This mark up makes used vehicles overvalued, interest rates skyrocket. Car dealerships offer loan terms as long as 10 years to make the purchase "affordable".

  1. What does it mean to "refinance the negative equity of their current vehicle back into the new one"?

  2. How does this mark up make used vehicles overvalued?

  3. How does this markup skyrocket interest rates?

1 Answer 1

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Refinance negative equity of current vehicle into new one?

Imagine this scenario:

  • Bought a car a year ago for 20K using a loan of 19K. So you have 1K of equity
  • Today you could sell the car for 14K but the loan balance is 16K.

If you sell the car for 14K you will have to pay the lender 2K out of your pocket because of the negative equity.

But car dealers today are worried, they need to sell new cars, and they have to have room nor the next model year cars. So to encourage sales they do the following.

They sell you a new car for 25K, with a loan balance of 27K to cover the cost of the new car, and the negative equity on the old car.

They are gambling that they can sell your old car for more than they told you it was worth. They are calculating that the interest rate they are charging you will generate enough income to make the overall transaction beneficial. They may do this by charging a higher rate.

These refinance the negative equity transactions won't be eligible for all those 6-8 year 0% interest loans they are advertising. They are only offering this deal if you meet their terms. You have to sell the old car to them, you have to get the financing though them.

Normally there are four items being negotiated when trading in an old car and buying a new car. The value of the old car, the price of the new car, the interest rate of the loan, and the length of the loan. Many people simply the negotiations at the dealership by either using somebody besides the dealership for the loan or by paying cash. They also sell the old car at another dealership. Thus being able to concentrate the negotiations on the price of the new car.

This pay off your old car loan with negative equity deals bring all four items in the deal into play, and the dealership limits your options so you will be eligible for this program.

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