Is Your Auto Loan Too Long?

October 13, 2008

When financing a new car, people seem to be willing to do anything for low monthly payments.

Right now, the average auto financing plan lasts 70 months–that’s almost six years. That trend for longer payments has only increased since last year. Last year, the average auto financing plan lasted 62 months. These days, expensive cars are beginning to feature nine-year financing plans. Moreover, some people take out additional loans, such as home equity loans, to pay off the cost of their vehicle, which they then gradually pay off over the course of 10 or more years.

People desire to make paying for their automobile a “painless” experience by lowering the amount they have to pay each month by as much as they possibly can. They appear not to realize how much they’re actually paying for this dubious “comfort.”

First of all, the longer you take to repay your loan, the more you’ll interest you’ll end up owing. Thus the longer you take repaying your loan, the more you’ll end up paying. You pay a certain percentage in interest for every dollar you owe every month. The sooner you start owing less–by making larger payments to take out larger chunks of your debt–the sooner the interest stops accruing on all those extra dollars.

At today’s comparatively low auto loan interest rates, you’ll end up paying over $38,000 on $30,000 vehicle if you take out a seven-year loan. Reduce the length of that loan to four years, and you’ll only be paying $34,400. Reduce that the length of that loan even more, and you might qualify for a zero-interest financing plan (provided your credit is good). This may be uncomfortable in the short run, but in the long run you’ll save money.

Additionally, cars’ tendency to lose value quickly makes long-lasting auto loans are an even worse idea. In this way, auto loans are in a sense opposite of home loans. It often makes sense to buy a long-lasting mortgage on a home, despite the bigger interest, because homes (usually) increase in value over time.

Long car loans with low monthly payments can often put you in the uncomfortable position of realizing that you owe more than you’ve bought. Your vehicle will have depreciated faster than you were able to pay off your loan.

This phenomenon, which proved so devastating to homeowners during the recent real estate crisis, is all-too-common among car owners. It is known as being “upside down” on your automobile. Over the course of a 9-year financing plan, your car can depreciate enough to put you in serious debt.

In any case, if you’re like most car owners, you’ll end up trading in your car long before that 6, 7, or 9 year loan is paid off. The average car owner keeps his or her car for only slightly over 5 years, before trading it in for a new one. Why plan to keep paying for a car long after you’ve ceased to own it.