The biggest factor contributing to longer financing terms is the rising price of a new car.
NEW YORK (PRWEB) June 27, 2018
The average person owns 12 cars in their lifetime, driving each vehicle for around six years. Today, it is possible to extend vehicle loans from seven to ten years, rather than the three to four year loans seen in the past. The problem with extended auto loans is that a vehicle loses value over time and with the average vehicle lasting roughly eight years or 150,000 miles, you could find yourself falling behind rather than getting ahead. While some cars can last 15 years or up to 300,000 miles, if properly maintained, most owners do not rely on vehicles to function for an extended period of time.
The biggest factor contributing to longer financing terms is the rising price of a new car. In 1950, you could buy a vehicle for around $850. Today, costs are at a record high. The average price of a new car is $30,000 and $19,329 for a used vehicle. When adjusting for inflation, based on the average price of a vehicle in 1975, the price would be $16,578. Instead, it is nearly double.
U.S. cities rely heavily on vehicles rather than public transportation, increasing both demand and prices. New technologies, safety improvements and regulatory changes also contribute to higher vehicle costs. Most people find owning a car is a basic necessity for most transportation needs, and higher costs prevent most buyers from paying cash.
Borrowing an average of $30,000 produces a higher monthly payment when a loan requires repayment in four or five years. Currently, 72% of new car loans and 59% of used car loans have terms, which exceed five years.
Affordability is a major reason for the trend towards longer car payments. For example, a four-year loan for $30,000 at 6% result in a payment of $711. Extending the loan for 96 months or eight years lowers the monthly amount due to $402 per month. According to Edmonds, the average monthly car payment is $479. Rising interest rates will continue to increase the total cost of financing a vehicle.
When comparing the high cost of buying a car with what constitutes an affordable monthly payment, and the high need for reliable transportation, it is easy to see why extended auto loans are becoming the norm rather than the exception. However, in many cases, these loans are not a good deal for the buyer. Before agreeing to an extended auto loan, review the following long-term consequences.
You Finance More Than the Vehicle Sticker Price
- In addition to the final negotiated price of the vehicle, many buyers finance loan fees, taxes, gap insurance, maintenance contracts, and other add-on costs the dealer pushes. When you include these extras, compounded with depreciation, an extended loan, can lock you into a car beyond its useful life. The higher financed amount also increases interest charges and leaves you underwater on the vehicle longer.
Owe More Than the Vehicles Worth
- Automobiles depreciate over time. Each year you own the car, the lower its value, in terms of resale and trade-in value.
- Vehicle depreciation, according to Edmunds research, amounts to an average of 11% of its value the moment you drive off the lot. During the first five years of ownership, it loses another 25% of its value each year. On a seven-year loan you will only pay off 12% of the value in the first year, leaving you upside down on the vehicle longer.
- If you decide to sell or trade in the vehicle before paying off the loan, you could owe more money than the value of the vehicle. When you trade in a vehicle with an outstanding balance, the debt transfers to the new car loan, further complicating the problem.
Interest Rates will jump
- When a car loan exceeds 60 months, interest rates tend to be higher because of the increased risk, raising the overall cost of the loan.
- The longer you extend the loan, the more you will pay for your vehicle because interest payments are also higher with each year of repayment. For example, (assuming the same interest rate for simplification), the above $30,000 loan paid off over four years, will result in paying $4,150 in interest. The lower payments extended over eight years, ups the interest payments to $8,552.
Paying for Repairs in Addition to the Car Payment
- Vehicles with higher mileage begin to require repairs. Keeping a car beyond five years means you need to add the cost of repair in addition to ongoing maintenance. Longer loans can mean you are making car payments when expensive repairs occur, increasing overall costs.
How Long Will You Keep the Vehicle?
- Will you drive the car for the length of the loan? Due to the higher loan costs and the depreciating value of the car, you could own the car beyond its useful life. You might also experience a life change that alters your transportation needs. For example, a growing family might find the need for a larger vehicle. Rising gas prices might lead to the desire for a more fuel-efficient option. A long-term loan can lock you into a car beyond your family’s need for the vehicle.
- Twenty years ago, the average loan was three years and an extended repayment was five years. Today, cars last longer, are more fuel efficient, have a lower environmental impact and include additional safety features. However, these improvements come at a significantly higher price. The rising price tag could tempt you to buy a car with a loan extended out to eight years or more.
- Doing so could leave you owing more than the value of the car and require you to keep the car longer than planned. From a purely financial perspective, entering into an extended loan contract is rarely a sound financial decision.
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