More and more new car buyers are financing their purchase for the maximum of seven years, and that has some worried that we may be headed for another financial collapse.
According to Experian Automotive, financing terms of 73 to 84 months accounted for 19.5 percent of all new vehicle loans as consumers are increasingly attracted by the lower monthly payments despite the fact that the terms typically exceed the length of time most people hang on to their vehicles.
Loans of 61 to 72 months, which were considered excessively long just a few years ago, now account for 41.7 percent of new vehicle loans. Experian reports that the number of short-term auto loans of 25 to 36 months have fallen by 24.7 percent.
Low interest rates and delinquency rates, combined with higher used vehicle prices and an aging inventory of used cars and trucks are seen as contributing factors. The average used vehicle price has risen from $25,703 in 2002 to $30,592 and the average age of vehicles on America’s roads is approximately 11 years.
Allen Foster is the general manager of Smart Motors in Madison, Wisconsin. He says 16 percent of his current loans average 72 months or longer. In 2010, these long-term loans accounted for just 11 percent of his business.
Consumers looking to trade in their aging vehicles are finding that their trade-ins have almost no value, and prices on new vehicles has increased thousands of dollars since they were last in the market.
The solution for many in this predicament is long-term financing, even if it means that they’ll wind up paying considerably more over the life of the loan when compared with a shorter term. For example, a 48-month loan with an interest rate of 3.94 percent on a $28,000 vehicle would mean monthly payments of $631.46. The total prepayment would be $30,310.08, of which $2,310.08 would go to interest on the loan. If the term is stretched out to 84 months, the total amount paid for the vehicle increases to $32,083.80, with interest payments totaling $4,083.80. The actual amount of the interest payments would probably be higher since longer-term loans typically have higher interest rates than short-term loans.
The danger, according to Bankrate.com senior financial analyst Greg McBride, is that longer term loans typically result in consumers owning more for their vehicles than they’re worth – a condition commonly known as being “upside down.” “You are going to pay down the balance at a snail’s pace while the vehicle depreciates rapidly,” says McBride.
Despite the fears of some industry experts that we could be heading toward a meltdown similar to the one that rocked the financial markets in 2008, some say the situation is not as bleak as it might appear.
Toyota Credit spokesman Justin Leach says the majority of those seeking longer term financing are people with higher credit scores and they tend to pay off their loans earlier.