A recent report from vehicle valuation site Edmunds shows that a record number of American car buyers – 12.7% – signed up in June 2022 for monthly payments of at least $1,000. Just a year ago, it was only 7.%, and in June 2019 it was just 4.6%.
The site also calculated how much additional interest consumers would pay on a $40,000 72-month car loan, which is more than two years longer than any auto loan money expert Clark Howard wants you to take!
According to Edmunds:
- Going from a 4% APR loan to a 5% APR loan would cost you $1,324 more in interest over the life of the loan.
- Going from a 4% APR loan to a 6% APR loan would cost you $2,672 more over the life of the loan.
3 Reasons Why Long Auto Loans Are Bad News
Longer auto loans are attractive to a lot of consumers because of the lower monthly payments, but there are several drawbacks to them.
1. They’re More Costly
Let’s say you finance $20,000 at 5% for five years. After three years, you’ll have paid $2,190.27 in interest and you’re left with a balance of $8,602.98 to pay over the remaining 24 months of the loan.
But what if you extended that loan term (at the same interest rate) by just 12 months?
After those same three years pass, you’ll have paid about $152 more in interest over the first 36 months, plus you’ll have a remaining balance of $10,747 to tackle over the remaining 36 months.
So the net effect of selecting a 72-month loan instead of a 60-month loan is that you’ll pay $545.62 more!
2. You’re Likely To Finance More Money
"The average loan amount for a six-year loan was $25,300, compared to $20,100 for a five-year loan," the Consumer Financial Protection Bureau wrote in 2017. "The average size of loans with terms of seven years or more was even larger at $32,200."
It’s always good advice to be smart about taking on debt, but because of the inflated vehicle market right now, Clark wants you to be especially careful about financing anything, including a car, right now.
“Unless you are sitting there with tons of cash, you don’t want to be in a position where you’re taking on new debt obligations. I don’t care how good the deal is, and I’m the deal guy,” Clark says. “Don’t buy ‘deals’ that would put you into debt.”
3. You Could End Up ‘Upside Down’
The longer your loan term, the greater likelihood that you could end up owing more than the car is worth, a term referred to as being “upside down.” With a shorter loan, your vehicle will likely retain more of its value by the time you’ve paid it off, compared to a longer loan.
Because of depreciation, your vehicle’s value will typically decrease as it ages, although how much depends on many factors. But you know what won’t decrease? Your car loan.
Regardless of a car’s value, if you still owe money on it, you’ll either have to pay off the existing loan or transfer it to your new loan. And that’s not a good scenario for your wallet.
Clark Howard: 42 Months Should Be Your Maximum Auto Loan Term
Clark Howard has long advised people that shorter is better when it comes to auto loan terms.
Final Thoughts
As you can see, there are multiple reasons why you should keep any automobile loan length to a minimum.
If you’re currently saddled with a long auto loan, Clark wants you to know that, if you can qualify for a lower interest rate, you should jump on it — as long as it doesn’t involve extending your the length.
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