Long Term Car Loans – Good Deal or Bad?

Long term loansSince the end of the Great Recession, average auto loan terms have become longer and longer. Forty-eight months was typical for a car loan just a few years ago but now that car companies are offering 6 year, 7 year, and even 8 year loan terms, the average is slowly creeping up as consumers take advantage.

Why are longer loans popular?

The short answer is that automobile buyers are simply looking for ways to make new car more affordable. A long-term loan produces much lower monthly payments than a shorter loan. Some car companies have provided encouragement through special offers of 0% APR interest rate for the longer terms. Consumers who might have considered a typical 3-year lease now might find that a 6 or 7 year loan produces similar or lower monthly payments. For those who know they’ll be driving their car for a long time, a long-term loan seems to be a better alternative.

What are potential problems with long-term loans?

The largest problem with long car loans is that the loan is “upside down” for most of the loan term. The loan balance is paid down more slowly than the rate at which the vehicle depreciates in value, which means there is always (until near loan end) a deficit or “negative equity” situation. In other words, the buyer has no ownership value in the vehicle that would allow him to easily sell or trade the vehicle until very late in the loan term. To sell or trade would mean producing a significant amount of cash to pay off the loan.

Many buyers who opt for a long-term loan may feel that they’ll keep the vehicle forever and that being upside down will not be a problem for them. However, statistics say that most buyers will want to get out of the old vehicle in about 4 years — which is why the 48 month loan average of the past was not a problem. For a buyer who drives, say, 25,000 miles a year, a vehicle would have 200,000 miles on its odometer at the end of an 8-year loan. That’s way beyond the lifetime of many vehicles. Therefore, a long-term loan exposes buyers to a bad situation in which they still owe money on a car that is either worn out or creating frequent expensive repairs.

The final problem caused by a long term loan is that finance costs can be very high. Unless the loan has a 0% or other special low-interest rate, interest rates for long loans are higher than for short loans — because the risk of loss is higher for the finance company or bank. As a result, finance costs are very high. For example, for a $30,000 loan at 8.0% for 84 months, finance cost alone are $9300, which makes a $30,000 car cost almost $40,000 by the time the loan is repaid.

Summary

Although long-term auto loans can produce very attractive monthly payments, even compared to leasing, they have disadvantages as well. Therefore, before jumping at such offers, make sure you have considered the potential problems and costs. ###

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