Longer Auto Loans Raise Red Flags
Mar 4th, 2015 @ 8:50 PM by Amber Nelson
The average length of a new car loan is getting longer and longer, but that might not be a good thing.
According to car research site Edmunds.com, new car loans now average a length of 67.2 months – roughly five-and-a-half years – reaching an all-time high. The historical average is closer to 4 years.
American car buyers are attracted to these longer loans – some can even be stretched out to eight years – because they can significantly lower the monthly payments allowing borrowers the chance to buyer nicer and newer cars. For example, a $30,000 new car loan with a 7-year term and a 5 percent interest rate would have a monthly payment of roughly $424 while a 4-year loan at 3 percent would require a payment of $664.
And auto dealers are loving the longer loan terms because they have made car-buying more affordable and raised auto sales to near-record highs in the past year.
Yet there are some significant concerns about such long car loans. As the example above shows, longer terms typically average higher interest rates as well. Lenders require more interest as a reward for the greater risk of long loans. That higher interest rate can translate into thousands of dollars more in payment and interest over the course of the loan.
Plus, because cars depreciate in value so quickly – after 3 years they are typically worth half their initial price – the lower payments on long auto loans means that buyers may find themselves in a position of negative equity – owing more on the loan than the car is worth. That makes it very difficult to sell the car if the need arises.
A few months ago even Ford Motor Company chairman Bill Ford warned that longer loan terms could be bad for the whole market. “I think we have to be careful because we don’t want to get into a situation like we did before, where consumers are over-extended,” he said in a CNBC interview last September. “That doesn’t do anybody any good.”
Amber Nelson is a seasoned mortgage industry writer and a regular contributor to Loan.com and Mortgage101.com.