Americans are taking on car loans longer than six years more than in the past, according to Experian Automotive, and that’s not the wisest financial choice for many people.
According to the latest Experian research, new-car loans that are longer than six years now represent 16.9 percent of all new-car loans, a 19.4 percent increase over last year. On the used-car side, 10.1 percent of all used-car loans are longer than six years — an 11.5 percent increase over 2012.
Longer-term car loans are attractive because monthly payments are smaller than on a shorter-term car loan. And, because they allow a car buyer to buy a more expensive car while still making the payment affordable, they can actually make things worse financially.
When it comes to buying a new car, the longer the car loan, the longer the owner will be ” upside-down” in the loan — where he owes more than the car is worth — unless there’s been a significant down payment. This is because a larger portion of the monthly payments early on in the loan is going toward interest. Being upside-down is dangerous, because if the car owner has a car accident where the car is considered a total loss, he could end up still having to pay off a loan on a car that he can no longer drive.
In addition, the longer an owner is upside-down in the car loan, the harder it is to have equity in the car, which means that when it is traded in, it may not count for much of a down payment on another car.
Finally, the longer the car loan, the more interest will be paid over the life of the loan, making the car cost more than a shorter car loan in the long run.
Even though depreciation is less of an issue with used cars, since a car depreciates the most in its first few years, long-term car loans on used cars aren’t a good idea, either. A used car already has a significant number of miles on it and a longer-term car loan would mean that the car will have higher mileage when it is finally paid off.
For example, assume that you buy a 3-year-old car with 36,000 miles on it, which is what the average American would drive in that length of time. If you take out a six-year loan and you drive 12,000 miles annually, the average in America, you would add 72,000 miles. This would mean your car would have 108,000 miles on it and would be approaching 10 years old by the time it’s paid off. If you choose to trade it in sooner, you may find it’s not worth much, or worse, that you have no equity at all.
While the lower monthly payment on a long-term car loan may be appealing at first, it is better for most car buyers to save up some additional cash to increase the down payment or to select a less expensive car so the monthly payment is affordable for a loan that is shorter.
Get more news, money-saving tips and expert advice by signing up for a free Bankrate newsletter.
Ask the adviser