Over the past 18 months, car buyers have become more willing to take out longer loans to afford a new car. As the average term of new auto loans has been stretched, borrowers are being presented with 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 US have 72-month terms. 60-month loans are the second most common term. Financing for 72 months or more now accounts for 43 percent of business, five points up from 2020 and eight points up from five years ago.
according to dr Cliff Robb, a professor of consumer science at the University of Wisconsin-Madison, says these periods run longer than the average time a driver typically owns a vehicle.
“The general idea is that after about five years, people tend to want a new vehicle,” he said news week. “And that’s what makes these loans so interesting. They take on a loan term that actually extends beyond the typical length of ownership.”
Most consumers, he added, go into the buying process thinking they’re going to drive a car until the wheels fall off. However, outside forces, such as the marketing of newer cars or someone close to them buying a new car, often persuade owners that they need to buy a newer car sooner than originally expected.
With years of financing still on the dealer’s ledger, drivers head to dealers’ properties looking for a newer car.
“Often you’re in a situation where your loan was more than the vehicle was worth,” Robb said. “So when you go to refinance, they’re just going to roll everything that was owed into the new loan. That way, you end up getting even more behind you.”
Tyson Jominy, vice president of data and analytics at JD Power, says ever-expanding auto loans are nothing new. “Long-term financing has been increasing throughout our lives,” he explained news week.
But what’s really changing, he argues, is the way consumers approach auto financing. Before the pandemic, 25 percent of new car purchases were leased. That number is currently 20 percent.
Taking out 60-, 72- and 84-month loans gives the average buyer lease-level monthly payments without the typical leasing constraints such as mileage limits.
Today, many car dealerships have less inventory to work with, and many charge premiums on top of the manufacturer’s suggested retail price (MSRP). With less negotiation of overpriced cars, there is a feeling that buyers don’t have many options to control when purchasing a vehicle.
“Buyers only have one lever in the buying process that they can control: the term,” says Jominy. That’s what buyers do.
Robb says the circumstance is giving way to upselling at retailers. A customer may want more options or a higher trim level if they have access to longer terms and therefore lower monthly payments.
Car manufacturers are also noticing the trend and are supplying high-quality options to dealers unless alternatives are specifically ordered.
He argues that when buying a vehicle, consumers focus on information that is easier to understand. In this case, illiterate buyers inherently think that a lower monthly payment is better.
“What we don’t always see is the fact that that lower monthly payment means we’re paying a lot more over the life of that car purchase than the value of the vehicle,” Robb said. “We often enter into these deals where we’re already behind in terms of value-to-loan dynamics.”
A recent study by Credit Karma showed that 23 percent of those surveyed regretted a vehicle purchase made in the last six to eight months. The two most common reasons were that the purchase set them back financially or they had trouble making monthly payments.
For Robb and Jominy, that doesn’t indicate conditions in the auto market, but rather other factors.
“That could indicate the overall consumer burden of rising costs and budgetary stress,” Robb said.
Jominy agreed, noting that far fewer subprime loans and leases are currently being made than before the 2008 financial crisis.
Subprime loans are usually defined as high-interest loans made to people with bad credit, usually below a FICO score of 600. The 2008 crisis began after a wave of subprime loans in the mortgage market defaulted and caused a chain reaction which affected numerous sectors of the economy, including automobile sales.
These longer maturities are proving to be an effective way to move inventory at the height of the pandemic, but Robb says longer-term loans serve as a powerful marketing tool to attract and retain a customer.
“I think long-term [dealers] will say, ‘Wow, this is a great opportunity for us to sell more vehicles more easily,'” said Robb. “It’s got all the selling points they love. The payments remain low. They will refinance it for you later if you wish to trade it in. So when you consider all of these things, if the consumer just ignores the cost, it all sounds good.”
If you’re looking for a new car, 60-month and 72-month (or longer) loans have pros and cons. On the plus side, you can lower your monthly payment. On the negative side, you can end up paying more than the car is worth 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.