Data from the credit bureau Experian shows that car loans continue to get bigger and longer. Borrowers, especially those with less than perfect credit, need to be careful. These longer-term auto loans may seem like an okay idea on the surface, but there are a lot of risks involved.
According to the latest findings from Experian, the average amount for both new and used car loans is at a record high. Consumers are combating these higher loan amounts by turning to longer-term loans.
Percentage of new car auto loans by term length:
- 49-60 months: 18.7%
- 61-72 months: 40.3%
- 73-84 months: 32.1%
Percentage of used car auto loans by term length:
- 49-60 months: 23.6%
- 61-72 months: 41.1%
- 73-84 months: 18.2%
People often turn to longer-term car loans because it lowers the monthly payment. This is a short-sighted approach, however, because extending the length of a loan increases the total cost of financing. There are other risks associated with longer-term auto loans as well.
Risks of Longer-Term Auto Loans
Consider these risks before committing to a car loan that's five years long or longer.
- You End Up Paying More in the Long Run - If you only focus on the monthly payment amount, it would appear that extending a loan term is a good thing for your wallet, as it makes the monthly payment lower. However, you can't lose sight of the total cost. For example, let's say you finance a $16,000 car at 4% interest for five years. The monthly payment would be $294.66 and you would pay $1,679.86 in interest for a total cost of $17,679.86. Now let's say you were to finance the same $16,000 car for seven years. However, because the term is longer, the interest rate jumps to 5%. Then, while the monthly payment drops to only $226.14, you wind up paying $2,995.97 in interest for a total cost of $18,995.97. As you can see, extending your loan term winds up making the total cost of financing more expensive.
- You'll Be Upside Down Much Longer - Cars are depreciating assets that lose value over time. Meanwhile, auto loans work in a way where you pay more in interest near the beginning of the term. This means that if you take out a long-term loan, the balance will not get paid down as quickly as the vehicle is depreciating. This will leave you owing more on the loan than the car is worth, which is known as having negative equity or being upside down. Having negative equity can lead to many complications, including making it more difficult to sell or trade in the car before the term is up. If you opt for a shorter loan, though, you can at least reduce the amount of time you are upside down for.
- The Future Represents a Big Unknown - It's impossible to predict the future, so do you really want to commit to the same vehicle for more than five years? A lot can change in six or seven years, and that can affect your vehicle needs big time. For example, you may be fine with a small sedan right now, but what if you start a family and need something bigger? Keeping a car loan term short can help you stay flexible and more able to adapt to the changes life brings.
The Bottom Line
If you have great credit, longer-term loans may not present too big of an issue. However, if you are dealing with less than perfect credit and can only qualify for higher interest rates, the length of your loan matters a great deal.
For these people, it never makes sense to stretch out the term. Keeping it short is the best way to curb the cost of financing, even if that means choosing a less expensive vehicle. If you keep it short, make the payments on time and improve your credit, you can be in a much better position to finance your next vehicle.
If you are struggling with credit problems and are trying to get approved for a car loan, you should know that Drivers Lane can help. Our service connects car buyers to local dealerships that specialize in helping people in all types of credit situations.
Get the process started by completing our free and easy car loan request form right now.