MONEY Autos

The Big Mistake More Car Buyers Are Making

We're extending the terms of our car loans, and it's costing us thousands.

The average length of new auto loans reached a record-high of 66 months, or 5.5 years, credit bureau Experian found in a report released this week.

More than 40% of all new loans signed for the first part of this year lasted 61 to 72 months, while loans extending out 73 to 84 months made up 25% of all new leases signed. Meaning less than 35% of us take out financing for five years or less.

And that’s costing us, big time.

“Beyond lower monthly payments there are no pros to this,” says Ron Montoya, consumer advice editor for Edmunds.com. “In fact there are a ton of reasons why you shouldn’t go past a five-year loan.”

Among the reasons for limiting loans to no more than five years:

Higher Interest Rates: The longer you finance a car, the more interest you’ll pay on it. Not just because you’ll be accruing interest and paying it off over a longer period, but because you’ll also be charged a higher interest rate for the loan.

“The best rates are offered between 36 to 60 months,” says Kelley Blue Book’s Alec Gutierrez. “Five years is really the breaking point; after that, rates jump up.”

Last year, the average interest rate for a new auto loan with a term between 55 to 60 months was 2.4%. That rate jumped to 4.8% when the term was between 73 to 84 months.

That means if you were to finance a car for the current average amount, $27,612, for 55 months at 2.4%, you’d pay $1,574.30 in finance charges. But if you were to finance that same car for 84 months at 4.8%, you’d pay $4,953.12 in charges.

The 84-month loan would “save” you $142.98 per month in payments, but cost $3,378.82 more in interest and give you about two-and-a-half years more of car payments.

Negative Equity: Whenever you first purchase a car, you’re considered underwater on it, meaning you owe more than the car is worth. The longer your car loan, the longer it will take you to build equity in your car and get “above water.”

If you have little or no equity in your car, you can’t sell it at a profit. A buyer will only pay what a car is worth, not what you owe on it. You’ll still have to cover the remaining balance. It works the same way with insurance companies if you get in an accident and your car is totaled.

Lower Resale Value: The longer you own a car, the less it’s worth and the less desirable it becomes.

Edmunds found that at five years, a car has lost 55% of its value, on average; at seven years, it’s down 68%. Dealerships and private buyers will pay less for your car, and that could hurt you if you were planning on using that money as a big source of your down payment for another car.

What to do before signing your next auto loan

Make a large down payment. Montoya recommends putting down 20% of the total car price, or as much as you can. This will bring the total amount you need to finance down.

Get preapproved financing. Before going into a dealership, apply for a loan with two or three financial intuitions you do business with, advises Gutierrez. This way, you know if you’re getting a fair offer from the dealership, and can ask the dealership to beat the bank’s offer.

Negotiate financing on total car price, not just on monthly payment. Use the total car price to run different monthly payment and interest scenarios to see if you’re being upsold or pushed into a longer loan with an online calculator like this one from Bankrate.

Consider cheaper options. If the car you’re looking at only fits into your budget with monthly payments stretched out over six or seven years, you may be shopping outside your actual price range. “Reassess your priorities and decide if you absolutely need that trim level, or even that model,” says Gutierrez, “because if you can squeeze into a five-year loan, it’s just smarter.”

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