Bennie D. Waller, Ph.D.

Car payments are a requirement for the vast majority of drivers, but the way borrowers repay their loans has evolved from a relatively short duration to a lengthy repayment period.
Earlier this year Experian Automotive found that the average auto loan term for a new vehicle reached a high of 65 months, or 5.5 years. This number has steadily increased from one financial quarter to the next, but showing how much progress has occurred in a decade illuminates a strengthening consumer trend.
A decade ago, the average auto loan term was a 60-month or five year term. Now, average loan terms are longer and consumers are offered more repayment methods. Two common options available today are loan terms of 84 months and 96 months — double the recommended term range of 48 to 60 months.
But are the additional options positive or negative for borrowers?
Pauliana Lara, managing attorney of the auto fraud division at Consumer Action Law Group, said difficult financial times are forcing consumers to reduce their monthly payments.
“The only way to do this is to extend the loan period,” she said.
Longer auto loans do reduce the monthly cost, but because lenders prefer to be repaid sooner rather than later, longer terms carry higher interest rates, which further add to the total cost of the vehicle.
For example, a 60-month auto loan on a $25,000 car with a 4 percent interest rate would equate to monthly payments of $460.41. The same car with a 84-month auto loan and a 4.5 percent interest rate would cost $347.50 monthly.
But despite the lower monthly payments, the 84-month repayment period would cost the borrower an additional $1,565.40 over the loans full term. This additional cost is purely interest.
Lara said seven-year repayment terms are ridiculous, especially for used cars, but she understands why consumers turn to the option.
“Desperate times call for desperate measures,” she said.
Loan terms are not the only area of finance that has ballooned to meet consumer demand. Auto loan balances are also increasing. The average loan amount for a vehicle in Q4 2012 was $26,691, up from $26,419 one year prior.
Additional studies further prove that American consumers rely more and more on financing to acquire a new or used car. Earlier this month, Experian found that a record high of 84.5 percent of consumers who got a new car during Q2 2013 used an auto loan or a lease for the purchase. This statistic increased 2 percent, from 82.5 percent, in one year’s time.
Davis McCabe, vice president of finance for HASCO Medical, attributes the lengthening of loan terms partially to longer car warranties. Ten-year warranties offered by car manufacturers such as Honda and Toyota give consumers extra security that their new vehicle will function properly in the future.
Although McCabe’s mobility company does offer 10-year financing, they only offer it as a final option.
“It hurts our sales cycle because customers want to trade in much sooner than 10 years and this will be difficult if they are not making extra payments,” he said.
The Car Depreciation Threat
One major concern for the average borrower is car depreciation. When terms extend past the recommended length, there is an added risk for negative equity. Similar to underwater mortgages, borrowers can face situations where their car is worth less than they owe on their auto loan due to the vehicle’s rapid depreciation levels.
“The longer the term of the car loan, the greater the vehicle depreciates,” Lara said.
On top of depreciation, drivers must pay for expensive car repairs. Most cars eventually need major and costly repairs, further adding to the borrower’s total auto cost.
Kristen Hall-Geisler, a freelance writer and author of “Take the Wheel: A Woman’s Guide to Buying a Car Her Own Damn Self,” said when drivers are still paying for a car over 100,000 miles, in addition to the repairs, the financial issue becomes an emotional issue.
“It’s frustrating to feel like you’re just throwing money away on this old car and you can’t afford a new one,” Hall-Geisler said.
She said that auto loan terms of 60 months or less are best.
McCabe prefers a lower extreme. He wishes that all auto loans carried four-year terms or less.
“It is unfortunate that people cannot do a 48-month loan because that is an ideal situation to not have to put yourself in another loan right away,” McCabe said.
More Options Equal Added Profit
The decision to accept a long term is in the consumer’s hands, but having this option is due to auto lenders and their ever increasing leniency with loan underwriting.
Car companies and their financial groups have expanded loan options since 2008 in order to increase business since the financial downturn, according to Hall-Geisler.
“If they can convince consumers to buy a new car with a lower monthly payment, despite the higher overall interest rate, they’ll make it happen,” she said.
Bennie Waller, professor of Finance and Real Estate at Longwood University, thought the poor lending practices that shocked the financial market years earlier would have corrected themselves, but they have not.
“It looks like some of these housing incentives are out there again and so are the car incentives,” he said.
The low monthly payment lure is fed by a desire to have more than a person needs or can afford.
“Everybody wants to drive the Tahoes and the Yukons,” Waller said.
The new revenue capabilities have become a vital part of a lender’s business plan. New and extended options are only available because it will make the lender a profit.
“It’s a good deal for lender’s or they wouldn’t do it,” he said.
Waller said that longer terms increase the lender’s yield.
The fact that this additional income is coming straight from the consumer’s pocket is hidden. The overall long-term cost is downplayed in advertising campaigns, whereas the lower monthly payment is marketed more highly. These new marketing create a skewed perception for consumers who mistake the added cost for a great deal.
Lara simply believes that these options are negative. Auto loan borrowers need the vehicles for transportation for work and school, but oftentimes they get trapped into the longer term loans and need to continue paying well past the vehicle’s value.
“The consumer’s hands are really tied,” she said.
In this situation, the lender gets the upper hand and the consumer is left with few options.
“At some point they stop making the payments and face repossession. It’s not a good situation for anyone except the lender,” Lara said.