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If you're struggling with car payments, you should downsize to something that is affordable even if it mean you have to take a loss. (Paul Vasarhelyi)
If you're struggling with car payments, you should downsize to something that is affordable even if it mean you have to take a loss. (Paul Vasarhelyi)

car debt

If you can't afford the car, hit the brakes Add to ...

In practical terms, a car is a source of transportation, but when it comes to buying a car, most people go above and beyond these practical needs. Many people end up paying a lot of money to get additional luxuries, which is fine, as long as you can afford it.

Experts say that you should be paying no more than 15 per cent to 18 per cent of your income for this "debt on wheels." This figure includes car payments, maintenance and car insurance. Anything above this means that you can't afford the car and would be wiser to settle for something within your means. Since many people look at buying a car from the perspective of monthly commitments, the golden rule is to buy a car that you can pay off within 36 months. If you cannot afford those payments, it means you can't afford it.

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But what if you've already bought too much car and you now can't afford it? A layoff, demotion, divorce or any drastic downturn in your financial situation could mean you are stuck with a fancy car and are staring at repossession or a bad credit report. Just what should you do?

To start, you need to confront the situation. It may be very hard to admit the fact that you're short of money and can't afford your dream car. But the earlier you make the decision to do something about the problem, the better. This way you avoid compounding the problem. At this point there are several options you can try to resolve the problem.

Go back to your car dealer

The first option is to return to your dealer and discuss the option of trading in your car for a less expensive one. Most dealers want you to stay with the brand and will have options to help you out.

However, this may not always work because the value of a new car depreciates quickly. This means that after a few months of owning the car, you may owe more than the current value. Imagine your car value has depreciated to $20,000 but you still owe $25,000 on it. Even if your dealer agrees to trade your car for a less expensive one, you will have to pay the difference of $5,000.

Refinance the car loan

The second option is to look at refinancing your car loan. You may try to extend the loan, or look for refinancing at a lower rate. Some finance companies may even offer a higher interest rate, which will cost you more, but will extend the loan period substantially. This could bring down your monthly payments.

Sell your car

Another good option is to sell your car and pay off the loan. If the car value is less than what you owe, you can consider taking a personal loan to cover the difference. Financing the difference with your credit card is a bad idea. Once you are free from the loan, you can make a wiser choice – buy a used car, use public transportation or get a bike.

In case of a lease

If you've leased the car, then it's a very different situation, because you don't own the car and can't sell it. You can return the vehicle back to the dealer, but you will still have to pay the remaining balance of the lease. You also lose the upfront money paid for the car and pay an additional recapture fee. A better option is to find someone who will be willing to take over the balance payments for your car. This is called a lease transfer and most leasing companies allow you to do that.

The bottom line

Like all deep in debt positions, it is important to take a hard look at your lack of financial wellbeing and seek help to get back on track. All stakeholders in a car purchase – the dealer, the financier and you - can minimize damage if you diagnose the condition quickly and act on it swiftly.

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