Longer car loan can handcuff buyer

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It seems that you can’t pick up a newspaper, go to a finance site like Bankrate.com or turn on a TV news show without hearing a lot of discussion about the subprime mortgage meltdown.

Now, the auto loan industry is reacting to spillover from that crisis in ways that might surprise you. Rather than cutting back on loan terms, lenders are lengthening their car loans as a way of avoiding defaults.

Toyota Financial Services is the latest lender to lengthen its car loan terms. Toyota announced this month that qualified buyers can get loans of up to 84 months — seven years of car payments.

Toyota says it extended the length of some loans to compete with online lenders and credit unions already offering 84-month loans. On some luxury or exotic cars, the company has gone so far as to offer 96-month loans.

From an industry standpoint, these longer loans put manufacturers in a Catch-22. As car prices rise and buyers want vehicles with luxury appointments, the only way to make the deal attractive is to offer lower monthly payments. This is especially true in today’s marketplace, where new vehicles sales are spiraling downward.

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But lenders also know that the default rate on these longer loans is higher than on loans of 60 months or less.

Even if you restrict these longer-term loans to people with credit scores of 700 and above, a lot can happen over seven years. Buyers can lose their jobs, get sick, get divorced or experience another life event that prevents them from making the loan payment.

According to the Power Information Network, nearly two-fifths of all new car loans are for terms ranging from 72 months to nearly 78 months. This year, new car loans made by the finance arms of Ford, GM and Chrysler have an average monthly payment of more than $500.

While all of these statistics should cause sleepless nights for some bankers and financiers, buyers should also be very cautious of these same trends.

Many buyers tend to look only at how low the monthly payment will be and how little they will have to put down. In addition, dealers often offer to roll over anything you owe on your current car into the new car loan, a come-on that is one more ingredient in a recipe for potential disaster.

Longer loans and lower down payments equate to a longer period in which you’re upside down on the loan — meaning you owe more than the vehicle is worth.

With an 84-month — or even a 72-month — loan and a minimal or nonexistent down payment, a buyer will likely still owe more than the car is worth four years into the loan.

That four-year mark is critical because many shoppers begin to get the new-car itch about four to five years after purchase. However, longer loans make it inadvisable to buy a new car at that time.

Also, these longer loans go beyond the warranty period of many new cars, meaning buyers could be facing car payments and possible hefty repair bills at the same time.

Buyers of sports cars and exotics may argue that their vehicles hold their values so well that even after seven or eight years, they still will have considerable equity. However, this overlooks how the interest on these longer-term loans jacks up the transaction cost considerably.

My advice? If you have to extend your car loan beyond five years and can’t afford to put at least 20 percent down, scale back your car desires to something you can afford.

If you do this just once on a new car purchase, you likely will be in much better shape for all of your future car purchases.

Here are this week’s reader questions:
Longer car loan can handcuff buyer
Am I responsible for my late father’s car lease?
Can I voluntarily surrender my car on my own?
What color car should I buy?

If you have a question for Terry, e-mail him at
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