Lenders rolled out an extra-long-term car loan last week: The 97 month loan. (That’s eight years, folks.) The lenders claim that this is because the average price of a new car has risen to $31,000 and extra-long loans are the only way that some buyers can get an affordable monthly payment. I’ve seen several reactions to this news this week, ranging from surprise to glee. But the reaction that surprised me the most was the feeling amongst some that this was a “necessary” maneuver.
The argument goes like this: Some people just need a break. They need to have a lower car payment so they can buy groceries, keep the electricity on, or be able to afford reliable transportation so they can get a better or second job. If they have a lower car payment, they can upgrade their job and maybe pay down some other bills. With a full warranty and no repairs to be made, that will free up cash in a strained budget to pay bills or pay down debt. With a better job and less debt, the person will be able to pay the loan back well before the eight years is up.
This is magical thinking. I’ll agree that some people could benefit from a lower car payment. But there are many ways to achieve that without signing an eight year loan. Buy a cheaper car. You don’t have to buy the $30,000 model or get all the bells and whistles. A smaller car with fewer features can be had for under $20,000. Buy a used car. Plenty of used cars have a lot of good life left in them. If you only need a car sporadically, think about renting, car sharing, carpooling, or becoming a one-car household. Don’t automatically assume that a $30,000 new car is your only option.
Extra-long loans are a decent alternative in only one scenario, and that is if you can make the commitment to paying them down far sooner than that eight year mark. And very few people will likely do that. Even those with the best of intentions will settle into the lower payment and opt to remain comfortable there, rather than stretching to pay it sooner. Even when you have extra money that can go toward that debt, most people will do other things with it. It’s just how most humans are wired.
The problems with these extra-long loans are many: You’ll pay way more interest than you would on a shorter loan. You’re taking out a long loan on a depreciating asset. This means that the chances are good you will end up upside-down on the loan before you pay it off. Many people don’t keep a car eight years so if you want to get something else, you’re going to have to come up with the money to pay off the old loan or (and this is the worst case) roll the old loan into a new one, putting yourself even further behind. If you get into an accident and the car is totaled, you may not get enough money to pay off the loan.
And that car is probably going to need repairs before the eight years is up. Since the warranty likely won’t last eight years, you’ll be on the hook for those repairs. Depending on how much you drive it, you’ll be looking at new tires and brakes as part of routine maintenance, and that’s assuming nothing major breaks. If you’re buying new with a long loan just to avoid repair costs it won’t work, or at least not for the whole length of the loan.
I’m not opposed to having a car payment. But people have to realize that taking a loan out on a depreciating asset means that the quicker you can pay that loan off, the better. A car loan should be taken out for the shortest term possible. An eight year loan is a dangerous thing and, if not handled correctly, could lead to more financial problems than it solves.
(Photo courtesy of goga.moga)