Approximately a quarter of all new car loans today are for at least 5 years, and some stretch to 6, 7 and even as long as 8 years. The reason that more and more consumers are getting these longer loans is simple; they allow for lower monthly payments and let someone who might only have been able to purchase a used car, or a much cheaper model, buy a fancier, more expensive car instead.
Edmunds.com, a research and car shopping website, says that the average new car/truck alone is 67.2 months, the longest it’s ever been, but it’s easy to find lenders will go for 84 months or even, amazingly, 96 months.
While the monthly payments might be lower, the fact is that, in the end, the overall cost that a consumer will pay for a long term car loan is much more than the same car will cost for a 2, 3 or even 4 year loan, for a number of reasons.
The fact is, on longer term auto loans the interest rate is usually higher because they’re considered more risky. For example, using 5% interest (which is still pretty good for a long-term loan), if a consumer took out a $30,000 loan for 84 months, they would pay $3700 more for their car than someone who purchased the same $30,000 car for 48 months at 3%.
Another problem with very long term loans is that, by the time a consumer gets to the sixth, seventh or eighth year of the loan, they could be paying more than the car is actually worth. According to Eric Lyman, vice president of industry insights at ALG (they’re the unit of TrueCar.com that forecasts depreciation) “The longer the loan, the further out is until you have positive equity.”
Until this change to positive equity actually occurs, meaning that you have a car that is worth more than what you still owe on it, if you go to trade in the car for a new one, your trade will have zero value.
What makes the situation worse is simply the fact that cars depreciate much faster than other major purchases. For example, by the time an automobile is three years old, it’s worth only about 50% of what it cost new. That means a $30,000 automobile would be worth approximately $15,000 when it becomes just three years old and, if you owe more than that when it does (which is highly likely if you have a car loan longer than 5 years) buying a new car will mean taking out an outsize loan big enough to pay off the old one and purchase a new one.
Another problem arises if you get into an accident and total your car, because most insurance covers the value of the car, not what you still owe on your loan. That means that, if you owe $25,000 on your car, but it’s only worth $20,000 because of it’s age, you’re going to get $5000 less than you need to replace it if it gets totaled in an accident.
At the end of the day car dealers and banks realize that most consumers don’t look at the end cost of their new car, but simply at the monthly cost when they’re making a new car buying decision. They know it’s a bad idea, but since they’re selling cars and making money, you can bet that they won’t point out that fact to consumers.
If that consumer happens to be you, the best advice you can follow is to take out as short a car loan as possible and, if the payments are too high, purchase a car that costs less rather than taking out a longer loan.
