Buying a new car is one of the biggest purchases many people ever make. But even for such a high-priced item, you should steer clear of what's becoming an increasingly popular way that many car buyers are financing their vehicles.
The scary trend in auto financing
Strapped for cash, more car buyers are taking on long-term loans to buy new vehicles. As a report in The Wall Street Journal discussed earlier this month, the average term for car loans late last year rose to a record-high 65 months. The proportion of loans ranging from six to seven years in length has grown by more than 50% since 2008, and some lenders are even offering 97-month car loans -- forcing you to make car payments for more than eight years.
The reason car buyers are taking on such long loans is pretty clear: Longer loans mean lower payments. With auto prices on the rise and even used-car prices remaining strong, buyers have little bargaining power in hoping for discounts and instead have to look to spread their payments out over longer periods of time.
3 reasons long loans are a bad move
Yet even with economic reality requiring many to consider longer auto-loan terms, there are many good reasons to consider alternatives. Even though you may have to put off buying a new car long enough to save more toward down payments, you'll be in a much better position to avoid these three pitfalls:
1. You'll be underwater on your car a lot longer.
As soon as you drive your car off the lot, its value drops below what you owe on your loan. With short-term loans, your payments quickly get you back to even, freeing you up to consider options like selling it or trading it in for another vehicle down the road.
With long-term loans, though, it can take years for you to get to the breakeven point. That means if you ever want to get rid of the car, you'll have to pay extra money upfront just to pay off your loan -- even after considering the trade-in value of your vehicle. That's not a good situation for anyone to be in.
2. You won't get as many promotional financing deals.
Many auto dealers offer low-cost loans as an incentive to buy. Over the years, Ford (F 1.92%), General Motors (GM 0.80%), and Chrysler all offered great financing deals to compete with more popular Japanese models. With Detroit now having rebounded, Honda (HMC 1.00%) and Toyota (TM 1.63%) have also renewed incentives that include financing deals. Even now, Ford offers 0% financing on some of its popular models, including the Focus pictured above.
But Ford's offer goes only with loans of up to 60 months. If you need longer-term financing, you may well end up paying a much higher interest rate, and combined with having to pay interest for a longer period of time, the result could be thousands of dollars in wasted money as a result of your needing lower monthly payments.
3. You'll strain your credit for other purchases.
Having an auto loan on the books may make it harder for you to get credit for other purposes, such as buying a home or getting a credit card. Even if you make payments on time, your monthly payment will sap available income to support other loan payments. That can leave you in the uncomfortable position of having your car keep you out of the home of your dreams.
The smarter move
As tough as it is to defer gratification, waiting until you can make a big down payment or settling for a less expensive vehicle to qualify for affordable short-term financing is the better way to buy a new car. Otherwise, you could end up digging yourself into a debt hole you'll have trouble ever getting out of.