Why That Long-Term Car Loan Could Be Costly

There were 17.4 million car sales last year, the most sales since the financial crisis, according to the U.S. Bureau of Economic Analysis. Alas, also on the rise is a financially questionable way to pay for the big-ticket purchase.

More than seven in 10 new cars purchased with a loan last year had a term of more than 60 months, according to Experian Automotive. While five-year loans have long been the most common, car loans lasting six to seven years have grown from 11 percent of the loan market in 2008 to 29 percent last year. The average car loan is now 67 months long. That's a far cry from how your grandfather financed his Buick; in the early 1970s, car loans averaged less than 36 months.

But long-term car loans aren't necessarily better. “If you are considering a new car loan beyond five years, it's a signal you are buying a car that is too expensive,” says Greg McBride, senior financial analyst at Bankrate. “People make the mistake of shopping based on what the monthly cost will be, rather than focusing on the total they will pay.”

Today, car loans for new cars average around $30,000. A 60-month loan that charges 3 percent interest works out to a monthly tab of $539, and total interest charges over the five years will come to $2,344. That same loan extended to 72 months—at the same 3 percent rate—results in a more palatable monthly cost of $456, but total interest costs rise to $2,818.

However, many lenders typically charge a higher interest rate on long-term car loans. For example, Chase bank recently advertised new car loans that charge a 2.6 percent rate for a 60-month loan, but 3.4 percent for a 72-month loan. On a $30,000 loan that increases your total interest payments from $2,025 to $3,206.

At Connexus Credit Union, which has customers nationwide, a 60-month car loan recently charged a 4 percent interest rate and an 84-month loan charged 6 percent. That higher rate, long-term car loan would cost a borrower $3,660 more over the life of a $30,000 loan. Unless you are the rare borrower who qualifies for a zero-rate deal (only one in 10 buyers typically does) a long-term car loan works against your long-term financial security.

The Case for Shorter-Term Loans

The next time you find yourself shopping for a car, focusing on these financing tips will help you to get the best car loan, and probably encourage you to avoid long-term car loans.

• Appreciate depreciation. The typical new car loses about 20 percent of its value the moment you leave the dealer’s lot, and it’s all downhill from there says Carroll Lachnit, consumer advice editor at Edmunds.com. The financial reality that you will never be able to sell your car for near what you paid should help motivate you to keep your total costs as low as possible, with a shorter-term loan being part of your strategy.
• Avoid negative equity.  Nearly one-third of new car buyers in January traded in a car at a price that was less than what they still owed on the loan for that trade-in, according to Edmunds. While the size of your down payment impacts your equity, so too does the length of the loan: The longer your loan term, the longer it takes to build equity. Even if you don’t anticipate trading in the car within a few years, if your car is stolen or totaled in an accident, the insurance payout will be based on its depreciated market value. If you are still in the early stages of a long-term loan (with a low down payment) you could be painfully “upside down” in car loan lingo.
• Focus on the bigger picture. Ignore shiny ads (and car salesmen) luring you with “affordable” monthly payments that invariably are based on long-term car loans. “Before you start shopping, give yourself a reality check by looking at the total all-in cost of your car based on different loan terms,” advises Lachnit. Noodling around with an online calculator will help you find your budget sweet spot. Then you can shop for the best deals at your price point.

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