Car Loans: Are Longer Terms a Bad Thing?

Source: David McNew/Getty Images News
Source: David McNew/Getty Images News

Any time you drive a really cool car, it’s inevitable that you’ll end up on the manufacturer’s website, configuring your ideal version of that car. As soon as you finish, you’ll look at the total price, laugh at the thought of spending that much money on a car, and then go back to trying to convince yourself that your current transportation situation is fine just the way it is.

After driving the Fiat 500 Abarth, I did exactly that as soon as I got home. Conveniently, Fiat includes a payment estimator with its configurator, but instead of quoting an absurdly high number like I expected, it told me I could buy the convertible version for $369 per month. My first thought was, “Oh no, I could actually afford to buy this car.”

Then I looked at the loan term it was using to calculate my payment. The reason my estimated payment was so low was because I’d have to pay that $369 for 72 months. In 72 months, I’ll be 32 and will have just celebrated my five-year wedding anniversary. Heck, I could even be a father by then. That’s much too far in the future to still be paying for a car.

Not long ago, the idea of taking out a 72-month car loan would have been absurd. Whether it is or not, it’s certainly not unheard of anymore. As Detroit News reports, the average car loan term is now 67 months for new cars and 62 months for used cars. Even worse, longer-than-normal terms of 73 to 84 months made up just barely under 30% of all vehicles financed in the first quarter of 2015.

The amount of money that customers are financing has gone up as well. In the first quarter of 2014, it was $27,612, but in 2015, it rose to $28,711. As a result, average monthly payments are now up from $474 to $485.

Longer terms on larger loans with higher payments have the potential to be a problem if more people end up defaulting on their loans, but there are definitely advantages to longer loan terms.

Source: Thinkstock
Source: Thinkstock

It’s normal for car prices to increase with inflation, and considering the advancements in technology over the last several years, no one should be surprised by that. The current Hyundai Sonata, for example, is so much better than it was in 2009, it’s easy to see why the new version costs more money. Unfortunately, with wages generally stagnant, the only way a lot of people can afford a new car is to take out a longer loan.

For some households, the problem isn’t necessarily that the monthly payment on a 36 month loan is too high. Instead, they’re worried that the larger payment will be cutting it too close every month. Being able to save several hundred dollars per month may make it worth paying more in the long run if it means having the cash on hand to cover unexpected costs such as medical bills. Paying $30,000 for a $24,000 car isn’t great, but credit card interest is much higher than car loan interest, which could end up being hugely beneficial in the long run.

Finally, even people who can afford to make higher payments are taking advantage of longer loan terms and low interest rates. If their investments are earning more interest than they are paying on a car loan, it only makes sense to leave that money invested instead of taking the shorter term.

The key to all of this, however, is to actually keep the car at least for the entire lease term. Most modern cars are just getting started at 100,000 miles, so keeping one for seven years is not a big deal, at least mechanically speaking. If someone does sell their car early, though, they’re almost guaranteed to owe more than it’s worth. That will mean either buying a lower quality car to replace the one that was just sold or rolling their remaining balance into their next car loan, putting them underwater the second they drive off the lot.

Melinda Zabritski, senior director of Experian Automotive, agrees, saying that “while longer term loans are growing, they do not necessarily represent an ominous sign for the market. It is critical for consumers to understand that if they take a long-term loan, they need to keep the car longer or could face negative equity should they chose to trade it in after only a few years.”

Longer loan terms might not necessarily represent impending doom and gloom, but buyers should definitely be cautious when taking out car loans, especially ones longer than 72 months. There are certainly benefits to longer loan terms, but there are also risks that should be seriously considered before signing up to pay for a new car over the next five to seven years.

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