In the last 18 months, car buyers have become more willing to take out bigger loans in order to buy a new car. As the average life of new car loans has been extended, borrowers are presented with some of the most favorable terms the market has experienced in a long time.
Fresh data from Lending Tree shows that most car loans in the US are for 72 months. Sixty month loans are the second most common duration. Funding for 72 months or more currently accounts for 43 percent of the business, up five points from 2020 and eight points from five years ago.
According to Dr. Cliff Robb, a professor of consumer science at the University of Wisconsin-Madison, these terms last longer than the average time a driver typically owns a vehicle.
“The general idea is that people – after about five years – tend to want a new vehicle,” he said. Newsweek. “And that’s what makes these loans so interesting. You put yourself in a loan term that actually goes beyond the standard property term.”
Most consumers, he added, enter the buying process thinking they will drive a car until the wheels fall off. However, outside forces, such as marketing newer cars or someone close to them buying a new car, often persuade homeowners to buy a newer car sooner than originally planned.
With years of funding still in the dealership book, drivers are heading to dealership lots looking for a newer car.
“You are often in a situation where your loan was more than the vehicle was worth,” Robb said. “So when you go for refinancing, they will just put in whatever they owed on the new loan. That way you will be even further behind in the end.”
Tyson Jominy, vice president of data and analysis at JD Power, says longer-term car loans are nothing new. “Extensive funding is growing throughout our lives,” he explained Newsweek.
But what really changes, he argues, is the way consumers approach car finance. Prior to the pandemic, 25% of new vehicle purchases were leases. This percentage is currently at 20%.
Borrowing 60, 72 and 84 months provides the average buyer with monthly lease payments without any of the standard lease restrictions such as mileage limits.
Today, many car dealers have less stock to work with and many charge premiums above the manufacturer’s suggested retail price (MSRP). With fewer deals on inflated cars, there is a sense that buyers do not have many options to check when making a vehicle purchase.
“Buyers have only one lever they can control in the buying process: the condition,” Jominy said. This is what buyers do.
Robb says the occasion gives way to upward sales in dealerships. A customer can enjoy more options or a higher level of care if they have access to higher terms and therefore lower monthly payments.
Automakers are also following the trend, sending high-quality options to dealerships, unless specifically ordered alternatives.
He argues that consumers tend to focus on information that is more understandable when dealing with the purchase of a vehicle. In this case, the educated buyers inherently believe that a lower monthly payment is better.
“What we do not always see is the fact that this lower monthly payment means that during this car purchase we are paying much more than the value of the vehicle,” Robb said. “We often enter into these contracts where we are already behind in terms of the dynamic value of the loan.”
ONE recent study by Credit Karma showed that 23 percent of respondents regretted buying a vehicle in the previous six to eight months. The two main reasons given were that the purchase made them financially backward or that they found it difficult to make monthly payments.
For Robb and Jominy, this does not indicate the conditions in the car market, but rather other factors.
“This may just indicate the wider consumer momentum at this time of rising costs and budget stress,” Robb said.
Jominy agreed, noting that there are far fewer subprime loans and leases currently being issued compared to the time leading up to the 2008 financial crisis.
Subprime loans are usually defined as high interest rate loans given to people with bad credit, usually below 600 FICO rating. The 2008 crisis began when a wave of high-risk mortgages in the mortgage market was delayed, triggering a chain reaction affecting many sectors of the economy, including car sales.
Demonstrating an effective way to move stocks to the top of the pandemic, these longer-term terms are here to stay, but Robb says longer-term loans serve as a powerful marketing tool to gain and retain a customer.
“I think in the long run [dealers] they’re going to say, “wow, that’s a great way to make more vehicles easier to sell,” Robb said. “It has all the outlets they love. Payments remain low. They will refinance it for you later if you want to trade. So with that in mind, if the consumer just ignores the cost, it all sounds good.”
If you are looking for a new car, there are pros and cons to 60 and 72 month (or longer) loans. The good news is that you can reduce your monthly payment. On the downside, you may end up paying more than the car is worth during the life of the loan. Experts agree that when financing a car, it is important to consider the total cost of the vehicle, including insurance and maintenance, rather than just the initial cost.