Advice on Secured Loans

By: Mike McGrath

Financial experts lecture consumers about the dangers of unsecured loans, like credit card debt. Money is borrowed, but there is often nothing to show for it but a receipt. No one worries about secured loans. Buy a house or a car and you have a payment book plus a large asset. That is the right way to borrow, we have all learned.

It is time to rethink. Increasingly consumers are borrowing more than the vehicle or house is worth, and a great deal of secured debt is no longer really secured by anything. If you owe $10,000 on a car that would sell for $8,000, you are said to be upside down on that loan. Really that just means that $2,000 of your debt isn't secured by that car. If you fail to make the payments and the lender repossesses the car, you will still owe $2,000 as an unsecured debt. Lenders are to blame for this. Auto dealers even advertise loans that add the unpaid balance of your old loan to a new loan. That is a despicable practice that will be outlawed as soon as the lenders start to lose money on the practice. Since lenders demonstrate no common sense, it is up to consumers to get smarter.

The Budget Doctor's prescription for secured loans:

1. Know what you can afford. If your budget permits 30% of your take home pay for housing and 15% for transportation, that is all you can spend.

2. Don't buy a monthly payment. Lenders understand that you want to buy as much as possible with the dollars you have. 84 month auto loans and adjustable rate mortgages are gimmicks lenders use to sell more than consumers can afford by permitting them to pay later. Homes should never have adjustable rate mortgages and mortgages should never be for more than 30 years. Vehicles should never be financed for more than 48 months unless they are made in Germany.

3. Don't assume you should get financing from an auto dealer or home builder. These folks have business arrangements with lenders. They get paid for getting your loans. Go to your own bank or credit union and tell them the terms you were offered. They are likely to do better. If the deal you are offered includes 0% financing or other special terms, understand that you are still paying finance charges one way or another.

4. Put some skin in the game. If you don't have at least a few dollars of your own money in a home or car, it is likely that you bought something you can't afford. Put at least 5% down on these purchases and you also lower your payments a bit.

5. Insure against being upside down. Your lender may insist that you buy mortgage insurance or gap insurance so that the lender is protected when the house burns down or the car is stolen. That is a cost you have because you didn't make an adequate down payment. Still, it is something you will need if you are upside down on a loan.

Buying what you can afford means looking at all costs. That includes the monthly payment, the cost of financing, the cost of gap insurance and the total cost. Always remember that you need to pay off everything before it becomes useless; that includes homes and cars and education and vacations. The cost of children is the one exception to this rule.

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