How to get out of an upside down car loan

I spend a lot of time browsing the personal finance subreddit (/r/personalfinance). There is plenty of bad advice and no shortage of people who pop into threads merely to pat themselves on the back for being better than whoever submitted the post, but there is still a lot of really helpful information posted there and I think most people who post there walk away better off than they were before they posted.

One thing that has always cracked me up a little is how /r/personalfinance talks about cars. Everyone on there HATES cars. No matter how cheap your current car is, there is always a cheaper one out there (that has been only driven to/from church by an old lady) and you need to sell yours and buy it ASAP before your financial world comes crashing down on you. If Jeff Bezos posted on there that he was driving a paid-off 1996 Honda Civic, /r/personalfinance would flog him for not getting a 1992. But, I digress…

The backlash against cars isn’t entirely unwarranted – cars are necessary for many Americans, but they are expensive and people often pay more than they should for more car than they need, and do so under terms that are less than ideal. It kills me to see people posting on there who have a car that should have cost around $15,000, have been paying $400/month on it for 3 years, and still owe $20,000 on it. Yikes. That happens more often than I could have ever imaged before spending time on that subreddit, and it brings us to the topic at hand.

If I’m upside down in my car, how do I get out of it?

Upside down, underwater, negative equity – these all mean that you owe more on your car than it is worth. This happens if you overpay for a car, roll other stuff into the loan, or have less-then-optimal terms (ie, zero down or 6-8 years for the loan). Even if you don’t overpay for your car and put some money down, there is a chance you’re underwater at some point on your loan – by many accounts, 1/3 or more of car loans are currently underwater at any given time.

If you pay your loan off, this isn’t a big deal most of the time – at some point in your loan, you’ll have a car that is worth more than you owe again and everything is fine. But, people often find themselves in unfortunate financial situations (often times greatly contributed to by the car itself) and need to shed the monthly payment.

This is where /r/personalfinance becomes unhelpful and possibly even a little dangerous. If you post a budget breakdown on there and your budget includes a car payment, chances are, one or more people will tell you to sell the car and buy a cheaper one – depending on how bad it is, it may be the #1 overall suggestion. While this may be useful advice in some situations, it is often easier said than done and people driving by in the thread to tell you to do that never stop to find out enough information to know if that is the case or not. Unfortunately, the more dire the situation, the more likely the chances that the person has any good options in this area.

If you are in a happy situation where your car is worth more than you owe, it is indeed quite simple – sell the car, collect a check for whatever equity you had in the car, and buy yourself something more reasonable. What if you owe more than the car is worth? Here are the options:

1) Sell the car to CarMax

CarMax is a national car chain, known for no-haggle prices and for being willing to purchase your car without any sort of commitment to buy one of their cars. This solution is often very heavily suggested to people in this situation, and it is easy and fairly low-risk. However, CarMax is not a charity and will not give you more than your car is worth – indeed, of the 3 options, they’ll usually net you the least.

That said, it certainly doesn’t hurt to get an offer from CarMax – at the very least, it will give you some idea of how other options stack up.

2) Sell the car private party

This route gives you the best opportunity to make the most off your car, thus limiting the damage a little bit. It also means the most work – listing the car, talking to buyers, dealing with flaky people, letting people take your car out for a test drive, etc. If you are in a tough spot financially, this work is often worth it.

It should be noted that one reason a lot of people cite for not going this route is the complication that this will add for the closing step. While coming up with the funds to cover the shortfall might take some work, the actual process of closing out your loan and selling the car to another buyer with their own loan is fairly easy – banks handle this situation all the time, and it isn’t a reason to not go this route.

3) Trade the car into a dealer

Another fairly easy option, especially if you are downgrading your car as part of this process. You’ll have to roll any negative equity into a new loan. There are two problems with this:

First, you are kicking the can down the road, not resolving the problem, and now you’ll have even more negative equity in your new vehicle, perpetuating your problem. This is a valid concern, but is often overblown and misses the point anyway – the negative equity you have is money that is gone and any way you get rid of it is going to cost you. If you’d have to take out a personal loan to make up the difference anyway, this option isn’t any worse than that (and might be a little better rate, too).

The second, and bigger, problem is that you may not be able to roll that much into a new loan. Banks limit how much they’re willing to loan above the value of the car that secures the loan – often to around 120%. So, if you are $5,000 in the hole on a $25,000 car and downgrade to a $10,000 car, you likely wouldn’t be able to make up the full difference this way.

4) Keep paying on the car

Often times this isn’t a terrible option, even if the situation isn’t ideal and people think you should get rid of it. Negative equity is a problem that will go away at some point in the loan lifetime, and trying to get rid of a car that you are upside down turns this problem into an immediate one that often requires a large outlay of cash.

5) Allow the car to be repossessed

If the situation is dire enough, then this may be your last and only option. Voluntary repossession is far preferable to having the bank have to hire a repo firm to do it for them – it’ll just add more onto the amount you owe. Note that giving the car back doesn’t get rid of negative equity or solve all your problems – you’ll still owe money to the bank, plus interest.

No Easy Way Out

There often is no easy way out of a bad car loan that you are upside down on, especially when someone is at the point where they are publicly asking for help to fix a bad financial situation. Advice to “just get rid of the car” is unhelpful without understanding all of the numbers involved – often doing so could make the situation even worse.

The other side of this is understanding how difficult it can be to get out of bad car financing situations – it makes a lot of sense to spend a lot of time on the process of buying a car to make sure you don’t get into situations like this.

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New Credit Card bonus categories for Q1 2017

A new year is here, and with it, new bonus categories for cards with rotating bonuses (Chase and Discover).

Chase Freedom

5% cashback on up to $1,500 in gas and ground transportation.

Discover, Discover it

5% cashback on up to $1,500 in purchases at gas stations, ground transportation, and warehouse clubs.

New Categories for Q3 2016

Chase Freedom‘s new bonus categories are Restaurants and Warehouse Clubs, both paying 5%. This bonus pays up to $75 for the quarter. This category is notable because Costco now accepts Visa cards, and the cash back at Costco is better than the Costco Anywhere card.

Discover’s new categories are Home Improvement and Amazon.com, both at 5% up to $75.

Also, the new Costco Anywhere visa is active and you can apply for it. It pays 4% on gas, 3% on restaurants and travel, 2% at Costco, and 1% everywhere else.

New bonus categories for Q2 2016

It is now the first day of Q2 2016, and there are new bonus categories for Discover and Chase.

Chase Freedom

5% cashback on up to $1,500 in purchases at grocery stores (excluding Target and Walmart) and Warehouse stores (like BJs or Sam’s Club)

Discover, Discover it

5% cashback on up to $1,500 in purchases at Restaurants and Move Theaters.

In other news, the Costco Visa card from Citi is looking like it will be a great cashback card – 4% on gas (up to $7,000 per year), 3% on travel and restaurants, 2% on Costco purchases, and 1% on everything else. We’ll have more info on this card once it launches in June.

Comparison of different debt repayment strategies

Scientific American recently asked, why don’t people manage debt better? It is a really good question, and the article does a good job of showing how people make seemingly-irrational decisions about how to pay down debt. The authors argue that the most optimal way to pay down debt is to use extra money to pay down the debt with the highest interest rate first – and they are correct in stating that it is the most mathematically optimal way to do it.

It isn’t the only, way, though and there are some good arguments that the mathematically optimal approach may not be optimal for other reasons. The “Snowball” approach, popularized by Dave Ramsey, is another approach that works well for a lot of people – it is less optimal from a mathematical perspective but more optimal from a psychological perspective in a lot of cases, and that is important.

We’ll compare 2 methods of paying debt down more quickly – paying the highest interest rate first, and the snowball method. This comparison assumes a few things – 1) You have more than one debt, 2) You have at least $1 beyond the minimum monthly payments to pay down your debts more quickly, 3) You aren’t accruing new debt.

Let’s assume you have 2 debts:

Name Amount Rate Minimum Payment
Car Loan $10,000 5% 100
Credit Card $24,000 15% 480

Now, let’s assume you only pay the minimums. How long will it take to pay them off and how much will you end up paying?

Name Time Interest Total Cost
Car Loan 10 years, 10 months $2,963 $12,963
Credit Card 6 years, 7 months $13,899 $37,899

You end up paying $16,862 in interest, or $50,862 total on an initial amount of $34,000.

Now, let’s assume you have an extra $250 per month to apply to your loans, and when you finish paying on one, you’ll apply the payment you were paying before to the remaining one.

1. Paying the highest interest rate first

In this method, you pay $730 per month on the credit card until it is paid down while paying only $100 on the car loan, then when the credit card is paid off, you apply the $730 per month to it for a total payment of $830 per month. Here is what that looks like:

Name Time Interest Total Cost
Car Loan 4 years, 4 months $1,710 $11,710
Credit Card 3 years, 7 months $7,103 $31,103

Your debt is paid off after 4 years and 4 months, instead of almost 11 years. You pay $8,813 in interest, or $42,813 total on an initial amount of $34,000. This is the most optimal way to pay the debt down, from the perspective of paying the least amount of interest.

2. Snowball (pay the one with the lowest outstanding amount first)

In this method, you pay $350 per month on the car loan until it is paid down while paying only $480 on the credit card, then when the car loan is paid off, you apply the $350 per month to it for a total payment of $830 per month. Here is what that looks like:

Name Time Interest Total Cost
Car Loan 2 years, 7 months $669 $10,669
Credit Card 4 years, 8 months $9,609 $33,609

Your debt is paid off after 4 years and 8 months, instead of almost 11 years. You pay $10,278 in interest, or $44,278 total on an initial amount of $34,000. You end up paying $1,465 more with the same set of parameters, except which debt you pay off first.

$1,465 is no small chunk of change. So, why would you consider this method? There are two reasonably good reasons:

a) The psychological effect. For a lot of people, making more progress on a smaller debt may motivate them to stick to their plan to pay off debt and increase the likelihood that they will be successful. If that is the difference between sticking to a debt repayment plan and not, then the $1,465 is a small price to pay.

b) There is another benefit in that in a shorter amount of time, you get some more free cash flow ($100 per month in this case) that can be used to absorb other unexpected expenses and help you avoid getting into more debt. In this case, we get more cash flow after just two and a half years, versus over 3 and a half years for the more optimal solution.

Conclusion

The method you use is largely up to you – do you value saving the most amount of money, or is the psychological effect of a quicker win more appealing? The important thing is you make a plan and stick to it, and that you are aware of the tradeoffs of each method.

Children Should Know The Cost Of Borrowing

Where I Came From

mother-child 2

When I was a child my parents were fiscally responsible.  They paid their bills, avoided debt, and conserved wherever they could. Despite having an average income they were able to eventually pay off their mortgage and gain some financial independence.

You may think this translated into a child who also had good financial habits, but unfortunately for me, that isn’t the case.  I struggled with excessive debt and poor budgeting well into my 20s.

During many of the most difficult times I found myself wondering exactly how I got into such a mess.  The answer came to me many years later. I had to have a few close calls with disaster, stand on the brink of financial ruin, and talk to a lot of smart people before I became open minded enough to really look for a solution.

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Ally adds Touch Id login feature to iOS app

A recent release of the Ally app for iOS has solved one of my biggest gripes with it – lack of Touch ID authentication. This allows you to login to your account with just your fingerprint, and makes logging in on a mobile device a lot easier.

My old bank – Capital One 360 – had this feature in their app for some time and I really missed it when I moved to Ally. You’d think it is a really small thing, but it is pretty handy to have. The only thing to consider is that if you allow Touch ID to unlock your bank account, anyone who can login to your phone can also login to your bank account – so be careful with it.

New features like this are one of the reasons Ally continues to be rated highly by those who use it.

My favorite personal finance book

Semit Rethi’s I Will Teach You To Be Rich is the best personal finance book I’ve found, and it’s the one I recommend to people who are starting to get their financial house in order, are new to investing, or are in their early 20s. If you’re older and are already in good shape financially, this book will be less useful.

Sethi’s book is a fairly easy read – it’s only a few hundred pages of easy-to-understand information, written in a pretty informal tone. He first explains credit cards and credit scores, and talks about things you can do to get fees waived, optimize your credit cards, and avoid falling into the trap of spending a lot of money on interest every month.

Next, he talks about finding a low-fee, high-interest bank account to keep your money in – in an era with low/no fee accounts that pay around 1% interest rates (at the time of this writing, at least), it is amazing how many people continue to pay unnecessary fees at banks that offer negligible interest rates (as a side note, our site – Best Savings Rates – can help you find the best place to keep your money).

Then, he tries to demystify investing. Investing your money wisely is the easiest way to become rich over time, but it is confusing for many people and it is easy to invest in ways that aren’t optimal. For years, I invested in individual stocks and watched as I paid lots of money in commissions, only to see less of a return than if I’d just stuck it in a boring index fund.

The section on investing is probably the most useful and important for people starting out – the sooner you start investing wisely, the more money you’ll have.

Sethi also goes over tracking your expenses (which is really important – how else will you know where you are spending more money?) and tries to keep things in context – rather than making you feel guilty for a latte here and there or eating out a lot, he tries to get you to focus on the important things.

The only things that aren’t great in this book are: 1) His examples of high-interest accounts are out of date, and 2) his advice about negotiating a car deal isn’t very good. Don’t follow it.

Overall, this book won’t make you rich quickly, but it will teach you how to save and invest your money wisely, so that you will be rich at some point in your life. It is available for less than ten bucks at Amazon, and I highly recommend it.

Best online savings accounts of January 2016

Best Savings Rates tracks online savings accounts, shows the ones with the highest interest rates, and collect reviews from users of those accounts. This is a summary of the best banks track by Best Savings Rates in January 2016.

Best Interest Rate

CIT Bank and Ally tied, both offering 1.0% APY. The median interest rate offered by banks tracked on our site was .65% APY, and the mean rate was .52%, so both of these banks are well above-average in that regard.

Best Overall Rating

The best overall ratings went to Ally (4.8/5.0 stars) and Discover (4.7/5.0) stars – both of these banks were given consistently high ratings by customers.

Best Customer Service Rating

We also gather feedback on customer service satisfaction – the winners of those were Citibank e-Savings (4.7/5.0 stars) and Ally (4.6/5.0).

Overall Winner

The “Best Savings Account for January 2016 from Best Savings Rates” goes to Ally – they were tied for the highest interest rate and received consistently good reviews from customers. Congrats Ally!

My ideas for dealing with excessive 401k fees

President Obama has recently turned his attention to retirement plans, as outlined in the The Wall Street Journal. One area of focus is the so-called fiduciary rule that would impose stricter regulations on advisors and force them to act in the best interests of those they advise, rather than taking actions to make more money at the expense of those they are advising.

I don’t think this is a bad idea, but there has been a lot of pushback from the financial industry (who wants to be able to continue to overcharge captive investors) and Republicans.

Indeed, companies and individuals who manage and advise employer-sponsored retirement plans often charge high fees, and many employees complain about this. I’ll give you one point of reference:

My employer uses Nationwide (who is most definitely not on my side) to manage our 401k. One example (that is more favorable to Nationwide than most of the other options) is the S&P 500 Index Fund. Nationwide’s expense ratio is 0.57%, whereas this same index costs me 0.17% in my Vanguard account (it actually costs .05%, because I have Admiral shares, but I’m trying to be fair) – the Nationwide one costs over 3 times as much for the exact same thing.

How significant is this difference? Assume a monthly contribution of $1,000, an average annual return of 7%, and a time period of 30 years – my fund at Nationwide would be worth $1,058,896, while the similar one at Vanguard would be worth $1,139,708 ($1,165,240 for the cheaper Admiral fund). That is a difference of over $80,000 – a really nice car! Keep in mind, this was one of the comparisons most favorable to Nationwide (many of the funds have a difference of 5 or 6x) and many 401Ks are even worse.

Why do 401K providers and advisors charge so much? Because they can. Employers setup plans and most fees are usually passed along to employees who have no say in which provider is used. Many employers setup plans when they are small and have little negotiating power, and as they grow, finding a better provider is never a high priority.

The Labor Department’s proposed rules would aim to alleviate this problem, by making it so providers have a fiduciary duty to plan participants but, as mentioned before, there is a lot of pushback on this. It still remains to be seen whether or not this rule will become law, and if it does, how effective it would be. Personally, I would prefer to see solutions to this problem that involve increasing competition. Specifically, I have two ideas:

1) Allow funds to go directly to an employee-specified qualified retirement account

In this scenario, employers can deposit retirement funds (including matching funds) directly into an IRA. The benefits to the employee are that they can choose their provider, and their retirement account is unlinked from their employer. The benefit to the employer is reduced complexity, reduced compliance costs, and reduced overhead in managing the program.

It would require a little more work in employee onboarding, but ultimately would benefit companies by sparing them the expense and effort involved in maintaining compliance, record keeping, and dealing with audits.

By allowing employees to choose where their funds are managed, they can shop around for the best management and lowest fees. If they want personalized advice for retirement, they can hire fee-based financial planners or go with a firm that advises them as part of their service, but they aren’t forced to pay for advisor services they aren’t using. This would encourage more financial service providers to offer competitive rates and service.

There are two downsides to this plan: Loans from your retirement account are no longer possible (at least under current rules), and dealing with matching funds that aren’t immediately vested is tricky.

The first problem – loans that are currently possible in some 401K accounts – doesn’t seem like that big of a deal to me. Most financial experts agree that this isn’t a great idea in the first place, so losing this ability isn’t the worst thing in the world. Alternatively, current rules around IRAs could be changed to allow for loans, but this could cause other problems.

The second problem – employer matches that don’t vest immediately – is a bit harder to solve. One solution is to simply say this option only applies to employers with no vesting schedule for matching funds. Another would be to allow the employer contribution to sit in another account and be eligible for transfer once the vesting period ends, but this adds additional complexity that doesn’t seem worth it. Ultimately, I think employers should be incentivized to provide plans with immediate vesting and provide alternative solutions for ones that choose not to.

Finally, what do you do about employees with no existing retirement accounts to contribute to? Employers could contract with a financial services company to provide default IRAs for employees, but employees would still be free to change providers at a later date, and the cost to an employer to change the default provider would be minimal (whereas changing 401K providers now involves a substantial amount of effort).

2) Allow annual in-service rollovers to IRAs

Another option (that could be used in addition to my first proposal) would be to make it so 401K participants can perform one in-service rollover to an IRA per year. Currently, participants can only do this when they terminate their employment, but allowing it to be done while they are still employed would let employees move their money to a more competitive provider.

This option is a little more complicated, and affords somewhat less cost savings to employees, but it requires fewer changes to the system as a whole. It also deals with the problem of partially-vested accounts – you can only roll over the vested portion of your account.

If providers knew participants could easily move their money elsewhere, they would be likely to offer better service and lower fees. If not, participants would be free to choose a better provider.

Ultimately, I think both of these proposals would be good for 401K participants and don’t significantly harm the goals of the 401K program. Plan providers and advisors accustomed to large, easy commissions may not like them, but they are good for everyone else involved.

I’d love to hear what other people think about these proposals? Are their better ones? Are there holes in these ideas that I’ve missed?

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