Let’s face it; most Americans love cars. Unfortunately, most Americans also have way too much car debt.

In an article from Auto Blog posted just a few months ago, they cited increases in new car pricing, and the effect those prices are having on family finances.

A study by Comerica Bank shows that the average purchase price of a new vehicle went up $300 in the second quarter versus the Q1, bringing the average transaction price to $26,300. The upward swing in prices came at a time when the average household income remained stagnant. The average family needs 22.1 weeks of median family income to pay for their new vehicle purchase…

It’s true; cars typically represent one of the largest expenses in a household budget. Only housing costs the average family more each month. Factor in gas, maintenance, taxes, repairs and insurance, and the cost of owning a car pushes even higher.

The most significant expense most people neglect to factor is depreciation.  New cars go down in value like a rock. Some new cars can lose as much as 20% of their original value when you drive it off the car lot. This quick depreciation, and the accelerated depreciation that often follows, leaves people owing much more in car loans than their car is worth.

If you find yourself in an upside down car loan, it is a safe bet your situation could be improved if you sell that “new” car and buy a much cheaper used one for your work commute. You may still owe money, but you’ll owe much less money, and that is almost always a good thing.

How to Get Out of An Upside Down Car Loan

1. The very first step to getting rid of an upside down car is to evaluate how much your current car is worth. Using sites like Kelley Blue Book and Edmunds, try to determine the amount of your current car’s private sale value (not trade-in, which is often much lower). Be sure to be honest about the condition of your car, and enter the exact mileage to get a good valuation.

2. Save $2,000 to buy a “beater” to get back and forth to work. If you really want to get out of your upside down car loan, now is the time to swallow your pride, and put aside your love of shiny cars. Over the next couple months, try to scrape up a couple thousand dollars to buy an old, ugly (but mechanically reliable) car to get you to work. That’s the only requirements. No sex appeal; no bells and whistles (and no car payment!).

3. Get an updated loan balance on upside down car. Contact your bank or auto finance company and get the current “pay off” balance on your car. Compare this figure to the estimated sale price from step one. Often times car owners discover that they are not really upside down after all. However, if you bought new with nothing down, and/or rolled the balance of your previous car loan into your new one, chances are you are in fact in an upside down car.

4. Contact local bank or credit union to pre-qualify loan for the difference. Let’s assume you owe $22,000 on a car estimated to be worth $17,000. Unless you have $5,000 sitting around, you are going to need help paying off the car loan when you sell the car (this is a required step to clear the title for the new owner).  Discuss options for a personal loan in the upside down amount. This step is a lot easier if your loan is already financed at a local bank or credit union. Simply explain to the loan officer that they are already exposed to $5,000 in unsecured liability based on the figures you’ve obtained.

5. Consider alternate sources of funding. If your bank or credit union won’t budge, or your car is financed through the manufacturer, you will have to look for other ways to fund the difference. If you have good credit, Lending Club is a potential source of financing. Tell your story as part of the borrower profile and ask for help in dumping your upside down car loan.

6. Get your car detailed, inside and out. Back when I was in the market for a car I was amazed to find so many dirty cars for sale. It doesn’t take a lot of money or time to give a car a thorough cleaning, and clean cars bring more cash, so there is definitely a return on your investment.

7. Advertise your car is for sale in every legal place you can think of – and include pictures. Pick up a “For Sale” sign at an office supply store and stick it in the windshield with your cell phone number. Place a flyer with color pics (take a couple good photos, design your own flyer in Microsoft Word or Photoshop, and get a few color copies made) on your gym’s bulletin board, at work (where allowable), and post on Craigslist, community classified sites, etc. Tell your Twitter followers, friends on Facebook, email distribution…everyone you know that you are trying to sell your car.

8. Create a bill of sale to provide buyer, and immediately drop your insurance coverage on old car. Since it might take a while to deposit the money from the buyer, and close out the financing on your loan for the difference owed to pay off your car, prepare a bill of sale for the new owner to show proof of transfer of ownership. Bill of Sale forms for your state can be found online at places like LegalZoom.com. Be sure to also get new owner’s mailing address (if different than listed on the bill of sale) so you can forward the title to them when the finance company returns it to you after loan is paid in full. Also, be sure to contact your insurance company immediately following the sale to update your policy.

With your upside down car gone, and the huge car payment replaced by a smaller loan payment, start a car replacement fund to prepare to buy your next car with cash. Over time, you will eventually be able to trade up in car, but only do so when you have the cash to pay for it. Who knows; you might even find yourself driving a million mile car one day and skipping car payments forever.

Photo by ozjimbob

“Geraldine”, a sassy lady portrayed by the late Flip Wilson, answered her husband thusly when he demanded an explanation for yet another new dress: “The Devil made me do it! I was walking down the street minding my own business when he snuck up behind me and pushed me into that dress store. He MADE me try on! Then he pulled a gun on me and forced me to buy it and sign your name to a check.”

Geraldine’s humor is timeless because so many of us can relate to it. For example, have you ever bought a new car and then wondered what possessed you to do it? I doubt if it was the devil, but the devil’s first cousin, car fever, will have the same results.

Do you currently own a car you wish you had never bought? Are you asking yourself if you should try to sell it or just live with it? This post is designed to help you think through this dilemma.

Start by asking yourself these questions:

How much do I owe on it?

If you paid cash, then you are probably not facing a financial crisis necessitating the sale of the car. If you simply don’t like the car, then take your time, sell it and pay cash for another one. If you are in debt, move on to question two.

How big a burden is this car on my budget?

If one hiccup in your life will cause you to start missing payments, then you need to amputate this car before that hiccup occurs. Even if you are easily making your payments, you still might be deceived into thinking all is well. Long term debt on a depreciating asset such as a car is a formula for staying perpetually in car debt. To break that cycle, you need to get the car paid off in 24 months or less and then keep driving it while you save cash for your next car. If you are on track to do so, then keep the car and enjoy it. If not, you should seriously consider getting rid of it.

If I am seriously considering selling, how do I go about it?

Knowledge is power. First, you need to learn if you are upside down (owe more than the car is worth). Check http://www.kbb.com/ to learn the private party value* of your car. If this value is less than what you owe, you are upside down. *(Use private party value because you are money ahead selling the car yourself).

But how does this work? Here is an example: You owe $22,000 on your “Geraldine” car and you could sell it for $18,000 (private party sale on www.kbb.com), thus putting you $4,000 upside down. If you decided to buy a $3,000 car (we will call the “beater”), your new debt would be $3,000 plus $4,000 = $7,000. You are still upside down, but you have eliminated $15,000 of debt.

How do I go about selling a car I am upside down on?

Unless you have an extra $4,000 available, you will need to borrow it in order to get the title released. So where do you borrow the money from?

Start by checking with the title holder. You have done your homework, so explain your rationale. In effect, you are asking for an unsecured loan on your upside down amount. Most lenders are not thrilled by this, but explain that this same amount of the current loan is already unsecured and you are simply asking that they move this amount from a more expensive car to a less expensive car.

If the title holder balks, don’t give up. Try your credit union or your home town bank, explaining that you will be moving your business to them. If you simply can’t find financing, consider other options such as selling stuff (Craigs List or Ebay or yard sales) or temporarily working a part time job.

REALITY CHECK: Are you ready to get your Geraldine car out of your life? Good! Doing so will not only be a huge relief, but will teach you to never again succumb to car fever. Still, you need to go into this decision with both eyes open, so the following pros and cons will help you preview the reality of your decision:

The Good

• LESS DEBT. You have just reduced your total debt by $15,000!
• OUT OF DEBT QUICKER: From our example, with an 8% loan and monthly payments of $400, your Geraldine car will be paid for in 5 years and 9 months. Your “beater”, on the other hand, will be paid off in only 19 months.
• STAY OUT OF DEBT: Once the beater is paid off, you could save $4,800 toward another car by making payments to yourself for one year. Assuming your beater would bring $2,000, you could upgrade to a $6,800 paid for car. Had you stuck with your Geraldine car, it would have depreciated to about $12,000 by now and you would still owe $13,300 on it.
• PEACE: You will know that you have taken the steps to undo that Geraldine decision. This is a great feeling.

The Reality Check

• INCONVENIENCE: Selling your car and buying another is a hassle.
• A DOWNGRADED DRIVE: Face it: your Geraldine car is nicer than a beater will be. Be prepared for it.
• LESS DEPENDABILITY: No doubt your beater will have some issues. You need to be realistic in assuming that it will not be as dependable as a newer car.
• MORE MAINTENANCE: With less dependability comes more maintenance.
• FRIENDS WON’T UNDERSTAND: Reality? Yes. Negative? Not really. Just be prepared for it.

One Final Reality Check

You may not be able to arrange the necessary financing. Why? Either your credit score is not adequate or you are too far upside down. Should this be your scenario, you will need to strategically pay down all other debt in order to free up enough cash flow to make huge car payments. Keep the car until it is paid off or you will be swimming in car debt for years to come.

Readers: Have you ever regretted a car purchase? What did you do and how did it work? What tips would you offer?

The other day I had problems with the old van I drive to and from work. A friend saw me struggling to get it started in my employer’s parking lot, and the next day said, “Man, I felt bad watching try to get the old van running. When do you think you’ll be able to buy a nicer car?”

That afternoon, while standing outside waiting on a ride home, and feeling a tad bit sorry for myself, it occurred to me that living frugal often gives people the wrong perception of your financial health. When others see you making frugal choices, they automatically assume you are doing it because you have to, not because you want to. Sure, I could go out and sign the next five years away with a new car loan, but I choose not to.

Over the last year or two there has been a growing trend towards frugality, and many people in the media are anxious to see if it lasts. Unfortunately, I don’t think it will, for one main reason.

Most Americans, myself included for far too much of my life, are overly concerned with what other people think of them. I mentioned the ability to ignore what others think of us briefly earlier this week, as part of my seven steps to financial independence, and Neal mentioned comparing ourselves to others in yesterday’s guest post. Living a frugal lifestyle means living within our means – our means, not within a fairytale lifestyle depicted in the media as the norm.

As we go through our day making little sacrifices here and there, voluntarily passing on opportunities to spend a lot of money, people not living a frugal lifestyle will naturally assume we can’t afford to keep up with them. That’s fine; you can’t control their thoughts and assumptions.

The fact is, most frugal people are in much better financial positions than those feeling sorry for them. The classic example is Sam Walton, who right up until his death drove an old pickup truck around Bentonville, Arkansas. Those who didn’t recognize him probably thought he was just an average guy not able to afford a “nicer car.” We know he could have easily carved $60,000 out of his billions for a shiny new Mercedes, but he didn’t need one. His old truck suited him just fine.

Unfortunately, most of us don’t think that way. So the thought of living frugal frightens many egos out there into thinking they may not appear as successful, or wealthy, if they shop at thrift stores, drive old cars, cut their own hair, clip coupons, and make their own homemade laundry detergent.

Just remember my take on a line from Dave Ramsey:  If people are laughing at you, or feeling sorry for you, you are probably doing something right when it comes to your financial plan.

The following guest post is from one of my favorite writers, Neal Frankle of Wealth Pilgrim. After reading the post, head over to Neal’s site and check out his free subscription options.

Let the Government go bail out somebody else.  It’s too expensive for you.

I’ll admit that I haven’t followed all the ins and outs of this program but I have two good reasons for not doing so:

1. I have a 1995 Camry that I love.  My two eldest daughters used it to get to and from high-school. I still have a ten-year old at home and my ultimate goal is for her to use it to get to high-school 6 years from now.
2. As long as I have a pulse, I will do everything I can to stop anyone I know from buying a new car.  It’s a complete waste of money in most cases.

So why am I bothering to write about this? Well, the subject came up over the weekend.  My daughter is thinking about getting a new car and “taking advantage” of the “Cash for Clunkers” program (with my beloved Camry no less!).  I’m dead set against it.

This program stinks worse than the junk you find when you clean out your trunk for one major reason:

It forces you to get rid of a very inexpensive mode of transportation and burdens you with a very expensive form of transportation.

An automobile is a device we use to move around.  That’s it.  It’s not a social statement or a tool to increase your self-esteem.  It’s a hunk of metal that moves you.

That being said, the question is, how do you get from point A to point B in the safest manner with the least cost. Right?  Am I missing something?

Let’s look at my Camry to illustrate the “virtues” of this program.  You tell me where I’m wrong.

Let’s take the first scenario where you trade in your clunker, receive $4500 and buy a new car.  What does it cost you to own that new car over the next 7 years?

A 2009 Camry (SE) costs a hair over $23,000 if you buy a new one.  Assume you buy it after turning in an old clunker, drive it for 7 years and sell it.  In this case, here’s how your numbers add up:

So, if you buy the new car, it will cost you about $1700 per year to own.  This is without the high cost of insurance you must buy when you own a new car.  It also excludes the jacked up price you paid for the new car because everyone wants one right now and it excludes the maintenance cost.  (I could not find good data on what it costs to maintain a used car.)

Now, lets assume you pass on the cash and drive your clunker.  Here’s what it costs you to own it per year:

This means you could spend up to $1400 per year on repairs and still save money vs owning a new car.  This assumes the car is safe and reliable for your particular needs.  In my case, my 1995 gem is perfect.

By the way, this analysis ignores the low cost for insurance for the used car.  No question about it, the clunker is better than the cash.

Will the clunker last another 7 years? Maybe not.  So let’s consider another alternative.

If and when my good old 1995 Camry dies, I’ll replace it with a 2 or 3 year old car.  It’s still going to be much cheaper than using this program.  Take a look:

I used the Toyota site to determine the new car prices.  I used the Kelly Blue Book site to get residual values. Again, this excludes the higher cost for insuring the new car but the lower maintenance expense. Buying used saves you $600 every year.

The bottom line is even with the clunker cash, it doesn’t make sense to buy a new car.  So just remember this, friends don’t let friends buy new cars.

Additional Reading:

• Cash for Clunkers Taxable?
• Cash for Clunkers Tax Rules

Over the weekend I took some time to complete a few finance tasks that have been stacking up on my to-do list for weeks. One of those tasks was to officially establish a car replacement fund.

Now that we have paid off our car, we recognize that it won’t last forever, so we might as well continue making “payments” to ourselves so we can pay cash for the next one. Since we have been in car debt our entire marriage up to this point, we are used to living without that $300-$400 we were sending to banks and finance companies over the last decade. Continuing to make a “car payment” to savings shouldn’t be that painful.

The Car Replacement Fund

As usual, I turned to ING Direct (read my ING Direct review) to handle my car replacement fund. I could get a slightly better rate with other banks, but the convenience of creating additional “sub-accounts” at ING, and seeing all my targeted savings accounts in one view, is key to my motivation.

We labeled the new account “Car Replacement” and scheduled a monthly transfer from checking for the exact amount of our most recent car payment (roughly $300). In just one year we should have around $3,600, plus a little interest. In two years we should be up around $7,500 – well within the range of replacing our car.

When the time comes we will sell the car via private sale, and put the proceeds with the cash in the car replacement fund. Based on an a depreciation estimate for our current vehicle, and the projected savings balance in two years, that should give us a solid $15,000 to look for a newer, used vehicle.

Over time we will continue this trend of upgrading every few years, but always doing it with cash. The schedule isn’t that much different than someone financing a new car, paying it off over 60 months and then financing a new one. Well, except we won’t be financing it from a bank – we’ll be using our savings.

I’m lucky; I’m not a “car guy.” I don’t drool over showroom models, and with only one exception, I’ve never really cared what I drove (there was that whole Isuzu Rodeo leasing saga). To me a car represents four tires and sheet metal with an engine to get you from point A to point B. It says nothing about who I am, my status, or my personality. Fortunately, my wife feels the same way.

Thanks to this utilitarian approach to car ownership, we simply look for the best value, not the sexiest design. Give me a beat up exterior with a solid engine and low miles any day. And driving that car without dragging a payment makes it just that much sweeter.

The July 1, 2009 edition of Bottom Line Personal, one of my favorite publications, included an excellent column on car maintenance tips. Columnist Eric Peters, author of Automotive Atrocities! The Cars We Love to Hate, shares his tips for maintaining cars and extending their useful life. As the owner of a 19 year-old vehicle, I appreciated the tips, and wondered if my vehicle would be in better shape had I read this several years ago when I first started driving it.

Five Maintenance Tips For Getting To 300,000 Miles

1. Keep your battery charged. This is especially important if you don’t drive your car that often. If you plan to let a vehicle sit for more than a couple weeks, you should invest in a “trickle charger,” or battery tender, which plugs into a regular household outlet and keeps your battery fully charged, automatically. I have a battery tender for my lawn tractor battery for winter months, and it guarantees a strong start in the spring.

2. Keep at least half a tank of gas in the car. Plenty of reasons not to let your car run on fumes, but one I had never considered before reading this article is that an empty gas tank is more prone to rust.  The rust can leach into your fuel and clog filters and fuel lines downstream. Rust could also eventually eat through your gas tank leaving a hole.  At today’s gas prices, who can afford for that to happen!

3. Don’t forget the tires. When you fill up your gas tank, or every couple weeks, whichever happens more frequently, be sure to check your tire pressure. If you drive an older vehicle like me you’ll need to pick up a tire gauge. Look at the label inside the door, or in your owner’s manual, to find the correct tire pressure for your specific model. Low tire pressure causes things like uneven wear on your tires and decreased gas mileage.

4. Change the oil. There is some debate in the frugal car owner world on whether or not you should change your oil as often as prescribed by car manufacturers (and those express oil-changing facilities). I’m no expert, but I think you should stay pretty close to the suggested schedule, only deviating a month or two, or a couple hundred miles. Peters agrees with me. Besides, a $30 oil change is much cheaper than a new engine, and if you are ultra frugal, you can even change your own oil!

5. Be kind to your clutch, and your brakes. If you drive a car with a manual transmission you know at some point you will likely have to replace the clutch. But you can extend the life of your clutch, and your brakes, by not riding either one for long periods of time, and by using your accelerator (or not using your accelerator) to coast a bit as traffic ebbs and flows.

Automobiles are becoming more and more expensive these days. In fact, next to buying a home, it is probably the largest single purchase most people will make in a lifetime. Use the steps above to increase the chances your vehicle will last well beyond your car loan, guaranteeing you many years of debt-free driving.

The House recently passed a Cash for Clunkers bill which aims to increase new car sales while getting older, inefficient ”clunkers” off the road. In exchange, participants can earn up to a $4,500 credit/voucher off the price of a new, more fuel-efficient car. Here’s why I don’t think it will work, and why I don’t plan to participate if it should become law.

Photo courtesy of dave 7

First of all, I think it is a mistake to create artificial demand for new cars by borrowing from taxpayers. I would much rather see the four billion dollars this program will likely cost be used to pay down some of our national debt, and let the creation of buyer’s incentives be left up to car manufacturers.

With unemployment still hovering around double digits (real unemployment is actually much higher), I doubt many people are going to rush out to buy a new car simply because the government is offering cash for clunkers. Environmental concerns aside, we’d be better off financially, continuing to drive our clunkers.

What if your so-called “clunker” is worth more than the value of the voucher? You might be able to get more from a straight-up trade in, or selling your vehicle private sale, than taking advantage of the cash for clunker offer. Of course, that option does not get the cars off the road, which is a close second objective of this bill–the first is to stimulate new car sales.

If you are on the fence about the cash for clunker program, perhaps the ever-increasing gas prices this summer will help change your mind. Do you think it is a coincidence prices are quickly approaching $3.00 per gallon?

This all reminds me of the $600 tax rebate checks, which had little effect (temporary, at best) on stimulating spending. When people are worried about losing their jobs, and already deep in debt, they are usually not in a spending mood. Any additional cash will be saved or used to pay down debt. I plan on keeping my clunkers, thank you very much.

Read more about the Cash for Clunkers program:

• Clunkers for Cash: Is It Even Worth It?
• 2009 Cash for Clunkers Program: Trade In Your Old Junker for Money
• Cash for Clunkers Taxable?