For Long-Term Auto Loans, How Long Is Too Long?

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By Hal Bundrick

Here's a disturbing question -- which lasts longer: the typical U.S. marriage or the average American car loan? According to The Economist, the average U.S. marriage lasts eight years. While six-year car loans are typical, eight year -- and even longer -- loans are growing in popularity. Experian says one-quarter of vehicle loan terms fell between 73 and 84 months last year, compared to just 11 percent of loans in 2008. So yes, car loans are beginning to give marriage a run for its money in the longevity department.

The most common term on new or used vehicles is the 72-month loan, comprising about 40 percent of the credit market. That's a substantial shelf life longer than the 36-month loan that launched the automotive finance industry. But Melinda Zabritski, senior director of automotive credit at Experian Automotive, says extended-term loans are not necessarily a bad thing. "Consumers tend to be monthly payment buyers," she said. "To keep that payment low, ... spread that payment out over a longer period."

Zabritski admits that you will pay more interest over the life of the loan, but she says consider the difference between the average rates on a typical loan amount at a 60-month term versus a 72-month loan: "You might only pay $500 or $600 more over the entire life of that loan but you'll save $50 or $75 a month. So the breakeven point comes pretty darn quick."

But average car loans are up nearly $1,000 from one year ago, to $28,381 -- the highest on record, according to Experian. The typical interest rate on a new vehicle loan was 4.5 percent, as of the fourth quarter of 2014. Put those factors together and the average monthly payment for a new vehicle hit $482, another record high.

Not only are vehicles more expensive, but consumer buying patterns have shifted, too. Entry-level crossover utility vehicles became the most-registered vehicle last year, followed by full-size pickup trucks, the usual top dog. During the recession, small economy cars were most sought-after by consumers though now, with the economy rebounding, Americans are upsizing again.

What About That Loan?

Zabritski says the most important factor to consider is: How long do you really plan to keep that car? Experian says the average length of initial ownership is 93 months -- almost eight years. Apparently we keep our cars about as long as our spouses. But when consumers put little or no money down and then keep a vehicle for just three years, it's easy to owe way more than the vehicle is worth when looking to trade.

"The days of buying a new car every three to five years are gone," Mark Seng of IHS Automotive told CNBC in a recent interview. "With vehicles lasting longer and having more technology, buyers are clearly willing to own their cars six or seven years, often longer. The one risk for buyers taking out seven-year auto loans is the chance they'll be upside down and owe more than their vehicle is worth if they try to sell it before the loan is paid off."

Edmunds, the automotive research firm, notes that the average trade-in age for a car in 2014 was six years. "It's not what you'd call an enduring relationship," Ronald Montoya, Edmunds consumer advice editor, wrote in a blog post. "If you have a 72-month loan and get the itch to buy a new car around the average six-year mark, you wouldn't have enjoyed any time without payments, which diminishes the point of car buying in the first place. At that point, you're better off leasing the car." And leasing is gaining popularity, accounting for nearly 30 percent of all new vehicles financed, according to Experian.

Resale Value an Issue

But Edmunds senior consumer advice editor Philip Reed notes another drawback to extended-term loans: resale or trade-in value.

"As a car depreciates, there are times when it depreciates steeply and other times when it's fairly flat," he said. "And you would like to trade it in at the end of a flat period rather than in the middle of a steep decline." He admits that every car is different in the manner in which it retains its value, but there are certain benchmarks to be aware of. "I would say that once you get past the five-year mark, not only is it depreciating quickly but you are also probably exceeding 100,000 miles." While that may not trigger a great deal of additional depreciation, he says it is "certainly a psychological barrier for many car shoppers."

If you're committed to long-term ownership and think an extended-term loan will work for you, Zabritski says it's important to shop rates and lenders before making a purchase. And remember, interest rates typically increase along with a loan term.

"We always recommend for folks to go ahead and look at getting prequalified with their own banking institution -- credit union, bank or whatever -- so that when they go to the dealership they are armed with that information to know what's a good deal when it comes to obtaining a loan," she says.

Hal M. Bundrick is a certified financial planner. Follow him on Twitter, @HalMBundrick.
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