Typical Loan Terms
Over time, the length of car loans has increased significantly. Edmunds.com reports that the average loan term was just over 6 1/2 years in 2014, as compared to a little over five years in 2002. Another telling statistic was that about 20 percent of loans were 73 months or longer in 2014.
Motives for Longer Terms
Several factors have contributed to loan terms of 73 to 84 months being commonplace as of 2015. Consumers and banks recognize that longer terms lead to lower monthly payments, which enable people to buy cars and often to spend more money on them. Banks also benefit from longer loan terms because they usually generate higher interest revenue. The competition within the banking sector for customer business causes many to quickly advance the length of auto loan terms offered to buyers.
Longer Term Risks
Though enticing because of the great vehicle affordability, long auto terms aren't necessarily financially beneficial for buyers. according to Bankrate. Even when
the interest rates are the same, higher portions of early payments go toward interest when you have a long repayment period. Thus, it takes longer to build equity in the vehicle than with a short-term loan.
When you put smaller amounts toward principal on the loan, Bankrate points out that you have a greater risk of being underwater on your loan. This problem is more often associated with new car purchases. Being underwater means that if you try to sell the car or suffer a total loss, you may still owe the bank money after collecting insurance. In contrast, a three- or four-year loan allows for fast build-up of equity and less chance of being underwater. For car shoppers concerned about high monthly payments, making a sizable down payment at the time of purchase not only leads to lower payments, but also reduces interest paid on the loan.
Bankrate notes that the risks of being underwater with a long-term loan are even greater with a new car purchase.
Category: Personal Finance