Yet last year’s median earnings of full-time U.S. workers was about half that much. And Bankrate.com says only 4 of 10 Americans have enough money saved to pay for a $1,000 unplanned expense, let alone enough savings for a $9,000-plus down payment. Moreover, rising interest rates and persistent microchip shortages are putting upward pressure on finance charges and vehicle prices.
So how do most folks afford a new car without committing financial hara-kiri? They stretch their loan length to 6 or 7 years to reduce their monthly payment.
Melinda Zabritski of the credit-reporting company Experian says 61- to 72-month loans were the most popular new-car loans last year and the percentage of 73- to 84-month loans rose from 29% to 34%. Four-year loans represented a tiny 5.4% of the total.
The longer the loan, the more a buyer will pay in total interest charges. But a long loan isn’t necessarily a problem—if the buyer keeps the vehicle for the length of the loan. However, things happen that cause buyers to sell or trade in their vehicle before the loan is paid off—job loss, a divorce, a new child. A buyer becomes sick and can’t drive—or just gets sick of the vehicle for one reason or another. Or a buyer might want a newer vehicle with the latest convenience and safety features.
And that raises the specter of negative equity, warns Zabritski. Vehicles almost always depreciate faster than it takes for buyers to pay off long loans, meaning that owners may owe more than the vehicles are worth if they sell or trade them in before the loan is paid in full.
Edmunds.com found that 44% of new-car sales in April 2020 involved a trade-in with negative equity. Typically, the only option for a cash-strapped buyer is to roll the negative equity of the old vehicle into a loan on the new vehicle, making it even more costly—possibly prohibitively so. Certainly, this is a trap to avoid.
So a word to the wise: Before committing to a long-term car loan, carefully consider if you’re truly a “buy-and-hold” kind of vehicle owner. If not, the better option might be a less expensive vehicle with a shorter loan.