In for the long haul: Lengthy auto loans become common, despite their costs

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Despite the danger of digging themselves into a financial hole, more Americans are signing on for longer terms on auto loans.

The numbers, from the
Consumer Bankers Association’s 1999 Automobile Finance Study, are startling.

The study found that in 1998:

  • Almost 75 percent of new-vehicle loans had terms of 49 months or longer.
  • More than 20 percent of new-vehicle loans were for 60 months or longer.
  • Sixty percent of all used-car loans had terms of 49 months or longer.
  • Twelve percent of used-car loans were for five years or longer.

The reasons for this swing toward longer financing are many. Experts cite everything from the increased durability of cars to easier lending standards. And it certainly helps that more lenders are offering longer-term loans such as a six-year loan.

Long loans more available

“It used to be considered too long. Cars didn’t last six years,” says Fritz Elmendorf, a spokesman for CBA. “Now more banks are offering them. For a consumer who wants one, it’s not that hard to find.”

There is also the often-costly combination of a shopper’s tendency to succumb to “new-car euphoria” and the desire of a dealer and a lender to pad profits.

People get their hearts set on a car and then try to find a way to afford it. Dealers and lenders are more than willing to help. A dealer wants you to buy a more expensive car and lenders like longer terms because of the additional interest.

“The dealers don’t explain the dangers of it and they have a lot more profits from it,” says Remar Sutton, president of the Consumer Task Force for Automotive Issues.

It’s not a hard sell. Dealers simply direct a shopper’s attention to the monthly payment. Then, the car that might bust a budget with payments over three years seems quite manageable when spread out over five or six years.

The same holds true for used car loans. To get more car and a lower monthly payment, you just need to lengthen that term.

“The sum of the payments will be significantly higher. But most people don’t care about that. They just want a lower monthly payment,” says Jack Nerad, author of
The Complete Idiot’s Guide to Buying or Leasing a Car.

The long and short of car loans:

Low monthly payments

mean higher total cost

A longer-term auto loan will drive down the monthly payment — but the overall cost of the loan will head upward. Longer loans tend to have slightly higher interest rates because they increase the statistical chance of default; and the interest payments mount over the years. Let’s say that you bought a new Camry, and after you loaded it up with options, traded in your old car and put down a modest down payment, you ended up financing $20,000. Here’s how the deal would look with loans of different lengths.

Number of years 3 4 5 6
Interest rate* 8.08% 8.1% 8.19% 8.2%
Monthly payment $627 $489 $407 $353
Total interest paid $2,588 $3,481 $4,440 $5,388
Difference in cost from a

3-year loan

$893 $1,852 $2,800
*Based on a June 24 survey of lenders

And they want to drive the car they want with all the bells and whistles.

“They’re getting more toys in their vehicles. They’re getting more upscale vehicles than in the past,” says Glenn Forbes, vice president of Transportation Business Development at
The Polk Company. “People wouldn’t think of buying a car without air conditioning, power windows and seats, and a deluxe stereo.”

Experts’ advice: Don’t do it!

The trend toward longer-term loans makes consumer experts cringe.

They urge people to limit loans to four years whenever possible. The reason? Stomaching a shorter-term loan with bigger monthly payments saves on interest and builds up equity.

But experts know that making those bigger payments can be a tall order.

“Yes, it does hurt,” says Mark Eskeldson, an auto expert and author of, a consumer information and advocacy Web site. “If it doesn’t hurt, you’re not doing it right.

“You should have tear stains on your monthly payment check.”

One way to take some of the sting out of that monthly payment is to plop down more upfront — the bigger the down payment in cash and trade-in, the lower the loan principal.

“My rule of thumb is if you can’t come up with 20 percent down payment, you can’t afford that car,” Nerad says.

You could easily turn upside down

A low- or no-down payment loan combined with a longer term is a sure way to get caught “upside down,” owing more on a car than it’s worth. Because all cars depreciate rapidly in their first two years, it’s not unusual for someone to be “upside down” a couple of years into a five- or six-year loan.

This is not a good place to be, especially if you decide to trade the car in for another one and have to roll the old car’s remaining debt into a new loan.

“It becomes a vicious cycle,” Sutton says.

To avoid such a fate, never finance a car for more months than you think you want to own it and, once again, opt for the biggest down payment and shortest term possible.

If you find yourself upside down, experts advise hanging onto the car as long as you can — at the very least until the amount left on the loan matches the car’s trade-in value. If you need to unload the car quickly, you might want to try selling it yourself. While you may only have a fifty-fifty chance of finding a buyer, such a sale would bring in $1,000 to $2,000 more than the trade-in value offered by a dealer.

Refinance, or pay ahead

Having second thoughts about the long-term loan that you took on last year? Consider refinancing the loan to a lower rate and term or simply paying ahead on the loan.

Make things simple for yourself with your next car purchase by taking a long, hard look at the your finances and decide how much car you can realistically afford. Then do some homework.

Compare prices, reliability studies and resale values. Also, check out discount financing deals and rebates from manufacturers. Much of this research can be done online by visiting Web sites such as
Edmund’s Automobile Buyers Guide,
Autopedia and
Kelley Blue Book.

Take some test drives. Once you’ve settled on a car, shop around for financing at banks, credit unions and independent financing companies. Have a financing deal in hand when you set foot on the car lot and then challenge the dealer to try to beat that offer.

“It involves a little work,” Eskeldson says. “If it’s too easy, it’s not a good deal.”

After all the work of landing a good car at a good price and at a good rate, make the most of your time and your money by hanging on to the car as long as you possibly can.

As Phil Garner, president of Consumer Credit Counseling Service of South Florida, says: “Buy a car and drive it until it falls apart.”