Today’s 72-month long-term auto loans don’t spell economic disaster, experts say
Over the past 18 months, car buyers have become more willing to take longer loans in order to afford a new car. As the average term of new auto loans has been lengthened, borrowers are offered some of the most favorable terms the market has seen in a long time.
New data from LendingTree shows that most auto loans in the United States last 72 months. Sixty month loans are the second most common term. Funding for 72 months or more currently accounts for 43% of business, up five points from 2020 and eight points from five years ago.
According to Dr. Cliff Robb, professor of consumer science at the University of Wisconsin-Madison, these terms last longer than the average length of time a driver typically owns a vehicle.
“The general idea is that people – after about five years – tend to want a new vehicle,” he said. News week. “And that’s what makes these loans so great. You’re committing to a loan term that actually exceeds the typical homeownership term.”
Most consumers, he added, go into the buying process with the belief that they will drive a car until the wheels fall off. However, outside forces, such as the marketing of newer cars or the purchase of a new car by a loved one, often convince owners that they need to buy a newer car sooner than expected.
With years of funding still in the dealer’s ledger, drivers are heading to dealerships in search of a newer car.
“A lot of times you’re in a situation where your loan was more than the value of the vehicle,” Robb said. “So when you go to refinance, they’re just going to transfer whatever was owed on the new loan. So you end up falling even further behind.”
Tyson Jominy, vice president of data and analytics at JD Power, says increasingly lengthy auto loans are nothing new. “Long-term funding has increased our whole life,” he told News week.
But what is really changing, he argues, is the way consumers approach auto financing. Before the pandemic, 25% of new vehicle purchases were rentals. This figure currently stands at 20 percent.
Taking out 60, 72 and 84 month term loans gives the average buyer monthly lease payments without any of the typical lease restrictions like mileage limits.
Today, many auto dealers have less inventory to work with, and many charge premiums on top of the Manufacturer’s Suggested Retail Price (MSRP). With less negotiation on cars with inflated prices, there is a feeling that buyers don’t have a lot of options they can control when purchasing a vehicle.
“Buyers have only one lever they can control in the buying process: the term,” Jominy said. This is what buyers do.
Robb says the circumstance gives way to upselling at the dealerships. A customer may accept more options or a higher level of finish if they have access to longer terms and, therefore, lower monthly payments.
Automakers are also noticing the trend, shipping high-quality options to dealerships unless alternatives are specially ordered.
He argues that consumers tend to focus on information that is easier to understand when purchasing a vehicle. In this case, undereducated buyers inherently believe that a lower monthly payment is better.
“What we don’t always see is the fact that this lower monthly payment means that over the life of that auto purchase, we are paying a lot more than the value of the vehicle,” Robb said. “We often enter into those contracts where we are already behind in terms of loan-value dynamics.”
A recent Credit Karma study found that 23% of respondents regretted a vehicle purchase made in the past six to eight months. The top two reasons given were that the purchase delayed them financially or that they were having trouble making the monthly payments.
For Robb and Jominy, this does not indicate automotive market conditions, but rather other factors.
“This may well indicate broader consumer pressure at this time of rising costs and budget stress,” Robb said.
Jominy agreed, noting that there are significantly fewer subprime loans and leases on offer at the moment compared to the run-up to the 2008 financial crisis.
Subprime loans are generally defined as high interest loans made to people with bad credit, typically below a FICO score of 600. The 2008 crisis began after a surge of subprime loans in the mortgage market has fallen behind, causing a chain reaction affecting many segments of the economy, including auto sales.
Proving an effective way to move inventory during the height of the pandemic, those longer-term terms are here to stay, but Robb says longer-term loans are a powerful marketing tool for winning and retaining a customer.
“I think in the long run [dealers] are going to say, “Wow, this is a great way for us to sell more vehicles more easily,” said Robb. “He has all the selling points that they love. Payments remain low. They will refinance it for you later if you want to trade it in. So considering all of these things, if the consumer just ignores the costs, everything looks good. “
If you’re in the market for a new car, loans at 60 and 72 months (or longer) have their pros and cons. On the plus side, you can lower your monthly payment. On the negative side, you could end up paying more than the value of the car over the life of the loan. Experts agree that when financing a car, it’s important to think about the total cost of the vehicle, including insurance and maintenance, rather than just the initial cost.