Americans are stretching out their car loans more and more. In June, the average loan length hit an all-time record of five years, nine months for new cars and five years, seven months for used cars, according to Edmunds.com. Some consumers are taking loans for up to seven years.
The lure of stretching out a loan is a lower monthly payment on a vehicle, especially an SUVs or truck, that’s increasingly expensive. But personal finance experts caution that if you opt for too long of a car loan, you could be risking debt troubles.
Indeed, problems are showing up in the default rate. Credit reporting firm Experian said loan delinquencies (payments 60 days late) are continuing to increase, hitting 1.7 percent of finance company loans and 0.7 percent of all auto loans.
Even buyers who keep up the payments and want to trade in their cars again may find themselves “upside down” with the used car that’s worth less than the payoff amount on the loan. This problem has worsened as used-car values have declined from oversupply as more cars come on the market as leases end.
The temptation then is to roll the old loan into a new one for a new car. “Not only do buyers not have a down payment, they’re adding the balance from their old loan,” said Greg McBride, chief financial analyst at Bankrate. “It can be an endless cycle.”
Here are some tips to help you avoid the pitfalls in these longer auto loans:
Make as large a down payment as you can. Putting cash up front reduces the principal and the payments of the loan — a much better option than stretching it out. For used cars, put up at least 20 percent if you can, advises McBride. The same amount is ideal for new cars, but if you can’t afford that, be sure to put at least 10 percent down.
Don’t take a loan longer than five years. Having a time limit helps you control your total spending. The longer the loan, the more you pay. “Going beyond five years is a big red flag,” says McBride.
Limit your auto expenses to 20 percent of your income. Make sure that all auto expenses, including fuel and maintenance, don’t exceed 20 percent of your gross income, counsels Edmunds.com. Remember with a newer car, your auto insurance payments will rise. Before starting to shop, work out a budget using a tool such as Edmunds affordability calculator.
In trying to limit your annual auto expenses, don’t stretch out your car payments too much. If payments are too high to handle on a loan of five years or less, consider a car that’s not as costly.