Longer Term Car Loans

The siren song from the dealer showroom is powerful and compelling. That new car’s a beauty. It’s got all the bells and whistles, and you sure would look a lot better behind its wheel than in the clunker you’re driving now.

After a few minutes of haggling, the dealer returns with a 48-month loan that carries payments of $615 a month. Crestfallen, you realize that payment will not fit into your monthly budget. That’s when the dealer suggests adding another year or two to the loan. By doing that, the monthly payments will decrease to $460. Sounds great, you say, where do I sign?

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Americans love their automobiles and they are willing to make a long-term commitment to buy them.

Vehicle loans are not only getting larger, they’re getting longer. The Consumer Bankers Association’s 2006 Automobile Finance Study showed the average loan in 2005 was for more than $23,000 and for the first time ever more than half were for five years or longer.   For years, the industry standard has been 36- or 48-month loans. In 2005, however, 55 percent of new car loans were for 60 or 72 months. The number of used car loans that fell in that category was 40 percent. These are staggering numbers considering that long term loans – those of at lease 60 months – accounted for only 22 percent of loan originations in 2000.

The only real advantage to a long-term loan is it gives consumers the opportunity to buy more car and fit the monthly payments into their budgets more painlessly. Dealers are willing to extend the loan to five or six years, and more buyers are using extended periods as their preferred method to pay.

            And pay.

 
For starters, while the monthly payments are lower, the number of payments is larger. Longer loans almost always carry a higher interest rate. A 36- or 48-month loan may have an interest rate of 6 percent. By contrast, A 60-month loan may carry one in excess of 7 percent. That difference could cost an extra $3,000 in interest payments. Higher interest also means less of your payment is applied to the principle each month.

In that heady rush to purchase a new car or truck, many consumers fail to account for the additional costs associated with vehicle ownership. In addition to gasoline and routine maintenance, there are unforeseen repairs that may come up during the life of the loan. If the wildly fluctuating prices of the past two years are any indication, there is not a way to accurately predict the cost of gasoline either.

In three years, that new car smell will be long gone, and so, too, may be the novelty of new vehicle ownership. With three years worth of payment coupons to go, the car may not be nearly as appealing as it once was.   At this point, you may be considering trading for a newer model.

Longer loans have led to a sharp increase in the number of owners who find themselves, “upside down.” Simply put, this is a phenomenon where buyers find themselves owing more on their loans than the vehicle is worth. According to J D Power and Associates, 29 percent of U.S. car buyers find themselves in this situation, owing an average of $3,700 more than their vehicle is worth. While dealers are willing to roll the difference owed into another new car loan, it often leaves consumers with a loan in excess of their new vehicle’s worth adding a new cycle of debt. New car values drop considerably in the first two years of the loan; sometimes losing as much as 20 percent the minute they are driven off the lot. With more money being applied to interest than in a shorter loan, the amount of equity built up is lower.

Also troubling is if you total the car, your insurance may not provide you enough money to pay off the loan creating the possibility of owing money on a vehicle you no longer own. Many insurance companies offer gap insurance to cover any potential difference between the balance of the loan and the value of the vehicle. Purchasing the insurance may increase peace of mind, but adds another auto-related expense.

There are ways to avoid becoming upside down. Paying more than the minimum monthly payment will decrease both the amount you owe and the time it takes to pay off the loan. Although long-term auto loans do not offer a great deal of flexibility, refinancing is an option. Making a higher down payment at the time of the purchase may allow for a smaller and shorter loan.

Preparation is also a key. Knowing what the additional costs of a 60 or 72 month loan are will help you make an informed decision. You may also have to settle for less car than you would like. That decision may be less satisfying in the short term, but may help avoid some long-term headaches.