Auto Loans Terms Lengthen as Average Affordability Drops
Jun 28th, 2017 @ 9:16 PM by Amber Nelson
The majority of Americans cannot truly afford to buy a new car, according to a new study by Bankrate.com http://www.bankrate.com/auto/new-car-affordability-survey/. The result is longer car loan terms, with some stretching as far as 8 years.
“The main point of this research is to illustrate how Americans are having to overextend themselves to pay for a new car at today’s prices,” said Bankrate.com analyst Claes Bell. “Low- and middle-income households are having to stretch loan terms to six or more years and/or spend huge percentages of their paychecks to afford reliable transportation, and it’s very difficult to get off that hamster wheel of debt once you’re on it.”
Using the long-standing “20/4/10” rule, Bankrate calculated average auto costs compared to average incomes in 25 of the largest U.S. metro areas. The “20/4/10” rule means that a borrower should put at least 20 percent down on a car loan, pay it off in no more than 4 years and spend no more than 10 percent of his or her annual income in auto loan payments.
According to that formula, the only metro area to be able to afford today’s $33,300 average price for a new car or light truck is Washington D.C. San Francisco is the next closest with a 2.93 percent gap between the average price and the affordable price for the area. At the bottom of the list is Miami, where the margin between the affordable and average vehicle price is almost 60 percent!
In order to compensate for this gap, many borrowers are taking out longer auto loans. According to Experian, 75 percent of all new-car loans have terms of more than 5 years. The main risk with long car loan terms is that the car will be worth less than the remaining loan balance within that time period. That would make it very difficult to sell the car and repay the loan if needed.
In order to meet the “20/4/10” rule, the majority of U.S. consumers would need to buy used-cars whose national average price is $19,200 today. That figure would make car-buying affordable in all but 8 of the top 25 metro areas.
Amber Nelson is a seasoned mortgage industry writer and a regular contributor to Loan.com and Mortgage101.com.