Longer loan terms may seem good, but they have higher interest costs and can expose you to other financial problems, such as owing more than your car is worth.
You're confident about the hot new sports car, but the monthly payments on your car loan aren't meeting your budget. The drummer sighed sympathetically and then said, "I have an idea how to make this work."
He recommends extending your car deals and loans to 72 or 84 months. He explains that your upfront payment will remain the same, but your monthly payment is lower. As he talks, you start imagining the coupe in the garage and show it to your friends.
But wait! Stop daydreaming. Oren Weintraub, president of Car Buying Concierge at AuthorityAuto.com, says that long-term car loan terms put you in a "vicious cycle of negative equity."
If you want to know where your car loan stands, check out the auto loan calculator at the end of this article. Doing so may even convince you that refinancing a car loan would be a good idea. But first, here are some statistics to show you why 72-month and 84-month car car deals and loans can rob you of financial stability and waste your money.
Shocking car buying statistics
Car deals and loans over 60 months are not the best way to finance cars because, on the one hand, they have higher interest rates on car deals and loans. In the first quarter of 2019, 38% of new car buyers had 61 - to 72-month loans, according to Experian. Even more striking, Experian's data shows that 32% of car buyers have signed up for car deals and loans of 73 to 84 months - equivalent to six to seven years.
"To close a deal, [car dealers] need to provide comfortable payment options," Weintraub said. "Instead of reducing the sale price of the car, they offered a loan." But, he adds, most dealers may not disclose how to change rates and cause other long-term financial problems for buyers.
Used car financing follows a similar pattern, with potentially worse results. Experian revealed that 42.1 per cent of used-car shoppers are taking out car deals and loans of 61 to 72 months, while 20 per cent of consumers are taking longer, with financing taking 73 to 84 months.
If you buy a three-year-old car and get an 84-month loan, it will take 10 years to pay off the loan. Imagine how it would feel to pay off a mortgage on the back of a battered 10-year history.
Long term loan terms are another tool for dealers to bring you into the car because they focus your attention on the monthly payment rather than the total fee. But just because you qualify for these long-term car deals and loans doesn't mean you should take them.
5 Reasons to Refuse a Long Term Loan
1. You are immediately "underwater". Underwater or upside down means you owe the credit more than the car is worth.
"Ideally, consumers should choose the shortest car loan they can afford," said Jesse Toprak, chief executive of Carhub.com. "The shorter the loan term, the faster the equity in your car will build up."
If you own your car assets, that means you can trade them or sell them at any time and make some cash.
2. It sets up negative equity cycles for you. Suppose you have to pay the car back before you can pay off the 72-month loan. Even after credit is given to you at a discounted price, you may still owe, for example, $4,000.
"Dealers will find a way to bury these four large sums in the next loan," says Mr Weintraub. "That money can then even be deposited into the next loan after that." Each time, the loan increases and so does your debt.
3. Interest rate over 60 months. Edmunds analyst Jeremy Acevedo said consumers will pay higher interest rates when they extend their car deals and loans for more than 60 months.
Not only that, but when consumers agree to longer car deals and loans, they apparently decide to borrow more, suggesting they are buying more expensive cars, including extras such as warranty or other products, or simply paying more for the same car, according to the Edmunds data.
When financing with maturities of 61 to 66 months, the average amount raised was $29,591 and the interest rate was 4.1%, bringing the monthly payment to $512. But when buyers agreed to extend the loan term to 67 to 72 months, the average amount of financing was $33,238 and the interest rate rose to 6.6%. This gives the buyer a monthly payment of $556.
4. You'll be struggling with repairs and paying off the loan. A six - or seven-year-old car might have more than 75,000 miles on it. A car this old is bound to require tires, brakes and other expensive maintenance, not to mention unexpected repairs.
Can you meet Experian's average loan payment of $550 and pay for car maintenance? If you buy an extended warranty, that will make the monthly payments higher.
5. Look at all the extra interest you'll be paying.
Interest is money. It can't even cut taxes. So look closely at the cost of extending your loan. Plug Edmunds' average into a car loan calculator, and someone who finances a car for 60 months for $27,615 at 2.8% will pay a total of $2,010 in interest. Someone who holds up a $30,001 car and finances it for 72 months at an average interest rate of 6.4% will pay three times as much, to $6,207.
So what's a car buyer to do? There are multiple ways to get the cars you want and fund them in a responsible way.
4 Strategies to Turn Things Around
1. Use a low APR loan to increase the cash flow of your investment. CarHub's Toprak says you only need a long-term loan if you can get one at a very low annual interest rate. Toyota, for example, is offering a 72-month loan for some models at 0.9%. So, instead of using a 60-month loan with a large upfront payment and paying a high monthly fee to tie up the money, invest the money you release, which can yield a higher return.
2. Refinance your bad car deals and loans. If your emotions take over and you sign a 72-month loan for the sports car, all is not lost. Assuming your credit is good, you can refinance your car loan on better terms without having to pay upfront penalties or fees.
3. Make a large upfront payment to cover depreciation. If you decide to take out a long-term loan, you can avoid being underwater by making a large down payment. If you do, you can trade without having to charge negative equity to the next loan.
4. Rent rather than buy. If you really want a sports coupe and can't afford it, you can rent it for a smaller upfront fee and a lower monthly payment. It's an option Weintraub occasionally suggests to its clients, he says, especially because there are some great rental deals. Then, if you still want to buy the car at the end of the lease, you are entitled to buy the car for the "residual value" specified in the contract.
Now that you know the damage a long-term loan can do and the needlessly high interest rate payments, take a moment to look at your car loan. Use our auto loan calculator to find out what you owe and how much you can save by refinancing.