How risky are long-term car loans?
Main Street and Wall Street are two different worlds and the inequality between them is greater than ever. Since the Great Recession, Wall Street has reached record highs, mainly due to the long-term record low interest rates. Main Street, on the other hand, performed less well. If you asked non-investors how they feel about the economy, the vast majority of them would complain. While equities have recovered from the Great Recession, the rest of the economy has not. Even if you look at many government companies, you will find that there is a lack of revenue growth and a lot of share buy back to make the stock prices rise higher. How does this fit in with long-term car loans?
Demand for new cars was low during the Great Recession. To stimulate the sale of new cars, lenders started pushing long-term car loans. By doing this, consumers who had previously taken out a loan on a used car started taking out loans on shiny new cars. It’s just too tempting for many consumers and car salesmen want to push more expensive cars because they make higher commissions. The problem is that long-term car loans lead consumers to live beyond their means. (For more: Bad Auto Loans – The Other Subprime Disaster.)
Living outside of your means?
When a consumer takes out a long-term car loan, they are intrigued by the lower monthly payments, but they really pay much more over the duration of the loan because of the higher interest rates. And the problems don’t end there. Most car manufacturers offer a five-year manufacturer’s warranty. If a consumer concludes a long-term Fanny Hillening that is longer than the standard 60 months, then that consumer is on hook for any transmission or engine repairs, which can be financially devastating. Another negative point is that technology and safety features will improve in the course of a long-term car loan, but consumers will be stuck with old technology. (For more information, see: New Wheels: Lease or Purchase? )
Long-term car loans have higher standard rates than traditional car loans. With a long-term car loan, the debt increases and some consumers are submerged – paying more than the value of the car. A car is a depreciation asset. That is why you want to pay off the debt as quickly as possible. The only exception is if a consumer can find a long-term car loan at a very low interest rate. This is rare. (For more information, see: Buying a car: the worst investment? )
Long-term car loans – which were longer than 60 months – were rare. Now they are used to. The average car loan is now 67 months and about 30% of all car loans are 72 months or more. American car sales have been high due to these trends.
Simple lending practices almost always lead to problems. In this case, many consumers take out more debts than they can handle. That capital could have been taken to a house (a valuable asset), a retirement or an emergency fund. (For more: The real cost of owning a car.)
The bottom line
Long-term car loans may offer lower monthly payments, but consumers pay higher interest rates, leading to higher total costs. All repairs required after the warranty fall under the borrower’s responsibility and the trade-in value of the car will be much lower if the loan is complete. All consumers must adhere to a maximum car loan of 36 months, even if that means buying a less impressive or used car. This is the financially responsible approach, and any saved capital could be directed towards a purchase, retirement or emergency fund. (For more information, see: Why you absolutely need an emergency fund .)