Americans are getting embroiled in long term loans, and not always for the right reasons. NPR even recently reported on the phenomenon, which has financial experts and even auto manufacturers like Honda up in arms. The concern is that borrowers are biting off far more than they can chew. This type of behavior puts them in a precarious position that can easily tip over the wrong way and have them piled under debt that far exceeds the vehicle’s value.
Yet, there are plenty of good reasons to opt for a longer car loan, not the least of which is that they are easier to manage for most households. If you are able to create a budget and stick with it, there is no reason that you cannot handle continuing to make payments past the typical 60 month mark. You can also take advantage of the more flexible payment expectations and stay afloat long enough to refinance or trade in the vehicle. Options like these make a longer loan term workable, but unless you have a long-term plan do not assume that a lengthy loan is a ticket to a free ride.
Why Longer Loans Can Be a Gamble for Some People
The biggest concern with a long term loan is that they have three main problems:
1. They typically have smaller down payment requirements
2. They typically have higher interest rates
3. The length of the loan means that your car is more likely to depreciate or have mechanical problems
These three factors combined can create a situation where a large principal balance combined with higher interest creates more debt than the car is worth. This scenario is called an “upside down loan” because the resale value of the car cannot pay off the loan in an emergency.
Should the owner get in a financial pinch where they need cash fast, selling the car is not an option because they will likely owe the remaining balance. Likewise, a vehicle that gets wrecked will not earn enough insurance money to pay off the remainder of the loan unless the owner also has gap insurance. For these reasons, buyers should be cautious before entering a loan longer than five years.
When a Longer Loan Could Work in Your Favor
Despite our warnings of gloom and doom, there are plenty of responsible adults out there who are more than capable of managing a longer loan term without getting into trouble. Examples of people who would benefit the most from 74+ month loans include someone who:
- Plans on driving the vehicle for most of its lifespan, including giving the car to a child when they turn 16
- Needs a low down payment and a low monthly payment in order to procure a vehicle to make ends meet
- Intends to refinance in 12-36 months so that they can get a better rate but keep the lower payments
- Wants to trade out of an inefficient car or one on its last legs before they sink any more money into it
- Will trade the car in once they have positive equity and finance a shorter loan
Scenarios like these allow people to actually save money during the life of their loan rather than paying out extra. Evaluate your finances and ensure that you have a financial safety net before deciding to commit to a long term loan. If you can prepare for an emergency and come out “right side up” rather than “upside down” in less than two years, you will have had a less stressful time doing so than people with shorter, more demanding loans.