The scary truth behind long-term auto loans

By Travis Peterson

Longer auto loans appeal to many buyers for their low monthly payments. But there is a hidden risk.

I just bought a new truck - well it’s new to me - and I made my first venture into the realm of auto financing. I was lucky enough in the past to buy vehicles directly from a family member and “finance” payments through them. No credit checks, interest rates, or loan terms to worry about. Just pay them back as said and agreed upon with a gentleman’s handshake.

But this time had to be different. I wanted to choose my vehicle, not simply default to the only available option. I wanted something newer, with lower miles—I’d never purchased a car with less than 80,000 miles on it. I wanted this one to be all mine.

So, I began my research: Craigslist, online dealers, reviews, car magazines. I looked into interest rates, credit scores, dealer incentives, and sales techniques. Then I went to a reputable used car dealership, because I knew that was the best bang for my buck, and browsed around for my primary mode of transport for the next ten years; I’m not one of those that buys a new vehicle every few years.

I found my truck, only two years old, low miles, and within my price range. As we negotiated price, I noticed the salesperson’s reluctance to mention the full price. I knew this tactic. Go straight to talking about monthly payments and show the customer that practically any vehicle on the lot is affordable.

He didn’t know the amount of research I do before large purchases. He didn’t know that I look at every payment option and analyze the overall cost ahead of time. I’m not going to throw away thousands of dollars just to reduce my monthly payment by $50. He didn’t know I was just browsing and had no intention of buying that day.

I was approved at an interest rate that pleased me. Did I mention I didn’t plan to buy that day? Now came the decision. How long do I want to make car payments? 60 months? 72 months? More? I saw the payment schedule. I noticed a slightly higher interest rate as the months increased. But the lower payment was so much more appealing. I knew there was an overall higher cost with the higher interest and longer term, but I still chose it.

Did I just make a huge mistake?

New research by TransUnion shows that the longer the term of an auto loan, the higher the likelihood of serious delinquency, defined as 60 days or more past due payment. This is somewhat surprising because it means that even though payments are lower, more loans with longer terms are not completed compared to shorter-term auto loans with higher monthly payments.

According to the TransUnion study, for prime consumers, those with average credit scores, the risk of serious delinquency is 3.4% for loans up to 60 months. However, the serious delinquency rate for loans of 73-84 months rises to 7.1%. For subprime borrowers, this number is even greater. Auto loans with terms up to 60 months see a serious delinquency rate of 22.4%, but that number skyrockets to 30.7% for terms over 72 months.

If the statistics hold true, the total number of delinquencies will continue to rise. In 2015, seven in ten loans had terms longer than 60 months, compared to only half in 2010. In this same span, loans with terms greater than 72 months have more than doubled. In Q3 of 2015, a quarter of all loans were between 73-84 months, up from only 10% in 2010.

So what are the effects of these long-term, lower monthly cost auto loans? Are these becoming too prevalent and could this possibly lead to an auto bubble similar to the housing bubble in 2008? Some, like John Oliver, think so as he recently suggested in his Last Week Tonight with John Oliver expose on auto financing. (Read my recap of the episode here)

So did I make a mistake in choosing a longer term? Did I just put myself at a higher risk and in fact purchase a vehicle I cannot afford? I hope not.

The truth is, decisions like these should not be made quickly. One should not enter an auto dealer without any prior research and education concerning financing. One should know what he can afford, and be able to translate that into a total price. It’s when we start stretching our means that we get into trouble, and often the necessity and desire for a vehicle outweighs the practicality of the purchase.

If you’re going to finance for six years, how confident are you that the car will last that duration? What possible repairs and maintenance will it require? What is the overall cost of the vehicle: insurance, gas, etc. Learn how your credit score affects your insurance premiums, the credit score you need to lease a car, and whether paying car insurance helps your credit.

But it’s not just about how much car you can afford. The other factors and costs in your life also play a part in your ability to maintain an auto loan. The same TransUnion study found that those with money left over after their monthly minimum payments had a much lower likelihood of serious delinquency.

This may seem like an obvious statement, a long-held truth about finance. However, oftentimes we stretch our spending to the furthest limits of our budget. Sometimes we even plan our spending and finances around anticipated future income or opportunity. As costs increase, expectations do not come to fruition, or hardships arise, what once seemed to be well within budget is now a burden.

And with long-term auto loans, that’s a long-term burden for many people.

About the Author

Travis Peterson is a Customer Success Specialist at Self.

Written on November 10, 2016

Self is a venture-backed startup that helps people build credit and savings. Comments? Questions? Send us a note at hello@self.inc.

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