The term of your loan is one of the three key factors that determines how much your car will ultimately cost you. And terms have been on the rise; auto loan lenders are seeing more and more six and seven year loans, so many that they made up a quarter of all loans issued last quarter. And as loans are growing rapidly, that means longer terms are making up a larger number of car loans.
But what’s driving the growth in long-term loan? And is it good for consumers?
There are a number of factors driving longer terms, but they really all boil down to cars costing more and consumers not seeing their wages rise accordingly. The average price of a new car has consistently rising for the last few years, and the cost of late-model used cars has risen as well. That’s made getting a monthly payment that fits many budgets a much tougher proposition on shorter terms. The increasing number of options, safety features, and luxury upgrades are also putting upwards pressure on prices.
Meanwhile, average wages and salaries in America have largely stayed stagnant over the last few years. So, as car prices go up, and Americans have to buy a new car based on the same salary they had from the last time, longer loan terms with smaller monthly payments look more and more appealing.
And, finally, people are making their payments on time. Part of the reason so many auto lenders capped terms to five years or less was concern that those longer-term loans wouldn’t be paid. But as the industry has been exploring longer term loans, they’ve found that people are more willing to make their payments over a longer stretch of time. But the question does remain … is this really the best way for consumers to go?
There are issues with longer term loans, especially for used cars, that consumer should be aware of before signing for them. The most common issue it that, simply, you’ll pay more overall for your car. The longer your term is, the more interest you’ll pay on the loan; for example, if you take out a $10,000 car loan over five years at 3% interest, you’ll ultimately pay $780 in interest across the life of the loan. Add just one year to that, though, and you’ll pay nearly $1000 in interest.
Another issue is the value of your car. As we’re all well too aware, cars will lose their value over time. The longer your loan extends, the less your car will be worth when you’re done paying for it. That will also mean you’ll have to borrow more for your next car than you might otherwise would.
Finally, there’s the issue of loans potentially going “underwater.” This is where loans cost more than what the car is actually worth. This is a financially precarious situation for a number of reasons, and it can cost you quite a bit.
That said, longer terms mean lower monthly payments. If a loan fits your budget, it’s worth considering. Just know what you’re committing to.