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Pricier cars drive longer loans

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By Chicago Tribune
Friday, April 26, 2013, 6:36 p.m.
 

As car prices continue to rise, some auto loan terms have lengthened to a whopping 96 months, or eight years.

It's an attempt to make monthly payments more affordable for consumers, but financial experts say such lengthy auto loans can be a bad idea.

The average price of a new automobile is $31,200, according to Kelley Blue Book. To make that more palatable for consumers, lenders are allowing them to spread payments over more years.

In March, nearly one-third of auto loans were for 72 months or longer, a record high, according to J.D. Power and Associates.

“It used to be that 36 months was considered a standard loan,” said Mike Sante, managing editor of Interest.com.

Because vehicles last longer today, consumers might justify taking a longer loan. The average age of a vehicle today is 11.

Jack Nerad, executive editorial director of Kelley Blue Book, said consumers are demanding pricey vehicles with smaller payments. “People want nicer cars with more stuff,” he said. “And they just can't afford it otherwise. It's up to people to make that decision.”

The trend toward longer loan terms might be aiding U.S. auto sales. New-car sales in March were the highest since August 2007, according to KBB.com.

But Richard Barrington, personal finance expert for MoneyRates.com, called it a disturbing trend and perhaps a sign of desperation for lenders and borrowers.

“Ultimately, it is just another way of getting people to take on more debt,” Barrington said. “It is also disturbing that people should feel the need to lengthen out car loans at a time when low interest rates have already made loan payments unusually affordable.”

A longer loan term often means buyers pay more interest — and higher interest rates — and stay “upside down” longer, meaning the borrower owes more than the vehicle is worth.

“When you talk about going to seven years to pay off a car, you are going to be underwater for five of those seven years,” Sante said. “That puts you in a bind if you need to sell the car.”

Many personal finance experts suggest the 20-4-10 rule. It means you should have a 20 percent down payment on a car loan, borrow for no more than four years and make sure car payments are no more than 10 percent of your gross income. Others express it as keeping payments lower than 20 percent of take-home pay.

“If you have to go past 48 months — and definitely if you have to go past 60 months — to get a monthly payment you can afford, you're spending too much money on that car,” Sante said. “It should really tell you something as a consumer.”

Consumers clearly aren't heeding that advice. Last year, 89 percent of auto loans exceeded the four-year rule, according to Experian Automotive. And the recent trend is toward longer loans. In 2010, about 9 percent of auto loans extended past six years. Last year, that rose to more than 16 percent.

 

 
 


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