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Research of the Week: Are Long Term Auto Loans the Best Commitment?

New data shows that borrowers are on-average extending terms to over 5 years. But are the benefits worth the cost?

Each week, Consolidated Credit searches for financial research that can help you deal with your debt and budget. This week…

The interesting study

The Credit Union Times recently published an article about how drivers are paying longer and more for car loans. The article featured information from Experian’s State of the Automotive Financial Market that includes data through the end of 2017.

The big result

Signing long term auto loans increases the total cost of financing

Long term auto loans are becoming the norm, where 10 years ago they used to be the exception. The average term for a new car auto loan is 69.1 months. That’s basically a term of five years and nine months for the average new car loan. Used car loans had an average term of 64.1 months or just over five years and three months.

The fascinating details

“What’s really interesting about these long term auto loans is that we don’t see any corresponding reduction in payment,” notes Gary Herman, President of Consolidated Credit. “Typically, you extend the term on the loan to lower your monthly payments. But payments hit an all-time high last year. This means people may be using long term auto loans to buy more car than they can really afford.”

  • The average monthly payment on a new car was $515, which was a record-high
    • For a used car, the avereage payment was $371
  • The average interest rates were also higher:
    • 11% for new car loans
    • 84% on used car loans
  • Consumers used auto loans to finance 85.1% of new car purchases made last year and 53.8% of used car purchases
  • Default rates on car loans remain relatively low at 0.75%

“The problem with long term auto loans isn’t a higher risk of default,” Herman explains. “The main issue is a matter of cost. Higher rates plus longer terms mean significantly higher costs overall. Considering how quickly vehicles depreciate, it makes you wonder if the car purchases are really worth what we’re financing.”

What you can do

“Most people don’t look closely enough at the Truth in Lending Disclosure they receive when they take out a loan,” Herman argues. “This document details all of the costs you can expect over the life of a loan. That includes monthly payments, total interest charges and total costs. Total cost is how much you finance in the loan plus total interest charges.”

For example, let’s say you don’t have good credit. This means your chances of getting a rate close to 5.11% on a new car loan are low. Your rate would be higher. If you financed $25,000 for 70 months at 10% APR, the monthly payments would be $473. The total cost would be $33,098. You pay around $8,098 in total interest charges.

“Car buyers really need to consider how long they plan on driving a vehicle,” Herman encourages. “If you get a 70-month auto loan and then want to sell the car or trade it in after five years, you’ll still have a balance owed on your auto loan. That means not only do you not get any money on the trade in, you may owe the lender.”

Ideally, you want to choose a loan term that allows you to pay off the car completely before you trade it in. That means you get the full value of the trade in as you purchase your next vehicle.

For more tips, visit Consolidated Credit’s free guide to Managing Auto Loan Debt.

Cutting Car Costs: Finding Smart Ways to Keep Transportation Costs Low

Cutting Car Costs

Money Management

Whether you’re buying new, buying used, or leasing, the cost of owning a car can be a serious budget drain. The average family spends over $10,000 per year on transportation costs. That’s 17 percent of the household budget. This guide helps you learn practical ways to cut car costs, so you can save money.

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