Like the many possessions that Americans have come to own, cars can be paid for by taking on debt. But recent data by Experian, one of the three major credit bureaus, shows consumers are increasingly likely to make unwise decisions when borrowing to pay for new cars — by taking on longer-term loans.
Car loans with repayment terms of 73 to 84 months were responsible for nearly 16 percent of new-car financing in the second quarter of this year, according to Experian data. In the first quarter, these long-term auto loans were responsible for a little more than 15 percent of new-car financing.
An increasing number of consumers hold long-term car loans that last as long as seven years. As of the second quarter of the year, the average repayment term for a new-car loan is 64 months, up from 63 months in 2008, according to Experian. According to comparable data from the Federal Reserve, loan terms for new cars averaged 62 months back in 2007.
Although many personal finance experts would recommend that consumers keep their cars for as long as possible, carrying a seven-year car loan is not advised — cash is often the ideal payment method for a car. With a longer loan duration, borrowers can expect to pay more in interest over the life of the loan, resulting in a higher total cost of the car. One benefit, however, is that the monthly payments would be lower.
A borrower who applies for a 5-year car loan for $25,714 (the average amount financed for a new vehicle) at 4.50% will have monthly payments of $479 and pay $3,026 in total interest. Another borrower who finances the same amount at the same rate with a 7-year loan will have monthly payments of $357 and pay a total of $4,274 in interest.
Consumers who plan to sell their cars early into the life of their loans are also advised against long loans because the amount owed on the loans is likely to exceed the value of the car.
The extra interest costs may act as a deterrent against these longer car loans but the Experian data shows otherwise.
“Because the overall lending environment has improved, lenders are making loans available to a wider range of customers,” said Melinda Zabritski, director of automotive credit for Experian Automotive, in a prepared statement. “This is good for manufacturers and dealers, as it allows them to sell more vehicles.”
Similar to all other loans, those who prefer to avoid paying more in interest should consider the shortest repayment terms available.