Car loans are getting longer. This is bad news.
Car sales this year are way up over last, but so is a disturbing trend: Many borrowers are financing their purchases with car loans far longer than the 48-month term we recommend.
Through June, credit data expert Experian reports it had seen a spike of more than 25% in the number of loans with terms from 73 to 84 months compared with the same period last year.
Nearly 20% of all new cars financed during the first half of 2013 were done so with these long-term loans.
We are convinced that extending the terms of a car loan beyond four years is simply a bad idea.
It's not a bad idea for the banks that want to charge you higher interest rates for longer periods of time. And it isn't a bad idea for car dealers who want to push you into more expensive vehicles.
But it is a bad idea for consumers who are resorting to longer terms to buy more car than they can really afford.
Average new car loans grow
Getting a car loan is slightly easier, but they've gotten longer and more expensive over the past 12 months.
|Characteristic||Q2 2012||Q2 2013|
|Loan term (months)||64||65|
|Source: Experian Information Solutions|
It's simple: The money you dump into buying a car is cash you don't have for other things, like saving for retirement or building an emergency fund.
Sure, spreading the loan over more years will lower your monthly payment, which eases short-term pain. But the additional interest payments alone could cost you hundreds or thousands of dollars extra.
If you borrowed $20,000 for 48 months at a 3.98% interest rate (that's the average car loan rate today, according to our national survey), the monthly payment would be about $451, our auto loan calculator shows.
Over 48 months, you would pay a total of $21,667.
At that same 3.98% rate for 84 months, your monthly payment would drop to $273. But those extra months of payments really add up.
By loan's end, you will have paid $22,948, or $1,281 more in interest.
That savings could buy a 60-inch TV or three semesters of textbooks for your college-bound teen. Or you could have used the extra four years without a monthly payment to bolster your 401(k) account.
Look, we all like new things. But if you're taking out a lengthy car loan, it's a good sign you should consider a cheaper vehicle.
There are all sorts of ways to determine if buying a new car makes sense. Our favorite is the 20/4/10 rule.
It will help determine the maximum you should spend on a car.
The rule says you should put down at least 20% on a vehicle, finance it for no more than four years and not let your total monthly vehicle expense (including principal, interest and insurance) exceed 10% of your gross income.
Following the 20/4/10 rule requires being honest with ourselves and probably scaling back our expectations.
But after all, a car is really just an appliance for getting us places.