Why a Lower Car Payment Can Be a Costly Mistake
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Buying a new car has always been a commitment. But with some auto loans today lasting longer than a lot of marriages, it’s especially important to know what you’re getting into.
The average new-car loan is now just a smidge under 70 months (5.8 years), and more than a quarter of new-car loans are longer than six years, according to the credit reporting agency Experian. That's a far cry from when your grandfather financed his Buick. In the early 1970s, car loans averaged less than three years.
The Case for Shorter-Term Loans
Keeping these tips in mind will help you avoid auto-financing pitfalls (and probably encourage you to avoid long-term car loans).
Appreciate depreciation. The typical new car can lose close to 22 percent of its value in the first year, says Mel Yu, a Consumer Reports automotive analyst, and it’s all downhill from there. This depreciation is why one of the smartest car-buying moves you can make is to shop for a used car that’s known for its reliability, Yu says. That way, the original owner pays for the big up-front depreciation hit. Have it inspected by a mechanic before you buy so you know you won’t be saddled with heavy repair costs. In July the average used-car buyer spent about 45 percent less than the average new-car buyer.
Keep it to four years. If you do finance, stick to a car budget that you can afford to pay off in no more than 48 months, or four years, says David Haas, a financial planner at Cereus Financial Advisors in Franklin Lakes, N.J. “If it’s a used car with just a few years on it, you can probably get at least another 10 years out of it," he points out. "That gives you a full six years or more of driving without making a monthly payment, allowing you to put that money toward other financial goals.” This strategy will also help you avoid buying more car than you can really afford.
Avoid negative equity. Though the size of your down payment affects your equity, so does the length of the loan. The longer your loan term, the longer it takes for the car to be worth more than you owe. That means that if you’re in the early stages of a long-term loan with a low down payment and your car is stolen or totaled in an accident, you could owe a lot more on the car than it’s worth. Insurance payouts are based on a car’s depreciated market value, so you’ll be left holding the bag.
Focus on the real bottom line. Don’t be distracted by “affordable” monthly payments that are invariably based on long-term loans. Instead, look at the total cost of your car based on different loan terms. Using an online calculator will help you find your budget sweet spot so that you can look for the best deals at your price.
Editor's Note: This article also appeared in the December 2017 issue of Consumer Reports magazine.
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