With new-car prices rising and averaging at around $30,000 in the first quarter of 2013, it’s no surprise people are leaning toward longer car loan terms, Consumer Reports noted in their Money Adviser newsletter published two months ago.
In effect, there are more banks now that offer auto loans with extended repayment terms. However, while longer loan terms have lower monthly payments, they can be more costly for borrowers.
Longer loan terms, with more repayment months, cost more because a borrower pays more interest. Moreover, they usually have higher interest rates than shorter terms.
To help consumers realize this quite hard truth, the staffs of Consumer Reports Money Adviser made some calculations to find out the difference between 4-year and 6-year auto loans on a car worth $32,765 with a $30,520 negotiated price.
This is what the team found: “The longer loan will cost you (consumer) about $1,600, assuming a 10 percent down payment. If you put 0 percent down, the difference climbs to more than $1,800.”
Upside-Down Auto Loans
Consumer Reports explained why longer loan terms are more risky: “That’s because cars depreciate over time, with the quickest loss in the early months.”
Cars depreciate faster than their buyers’ payments. A borrower would not be able to defeat this natural loss unless with a sizeable down payment or a high trade-in value, Consumer Reports added.
Being upside down—state where a borrower owes more than the market value of his or her car—on a loan is one big disadvantage that Consumer Reports pointed out. A borrower would normally outgo this state as he or she pays off the loan. However, repaying in a longer term will take a consumer longer before reaching this point.
Moreover, a borrower would not be able to get a good value, most likely an insufficient amount to pay off the loan, if he or she decides to trade in the car. In case of severe damage or theft, his or her insurer can only pay him or her at maximum an amount equivalent to the car’s depreciated value. That amount is rarely enough to pay off the unpaid loan amount.
The High Costs in Leases
According to Consumer Reports, car buyers opt to lease a car as another way to afford today’s pricier cars with lower monthly payments. However, it may not be that money-saving.
The thing with leases is the car buyer is “borrowing the entire value of the vehicle” with the down payment or trade-in subtracted. In that case, the buyer still pays interest every month.
And while a buyer surely pays lower monthly payments with a lease, there are taxes and fees that make the transaction still costly. Lessees pay tax on the monthly payments. However in some states, lessees are required by law to pay taxes on the finance charges. Add to that acquisition fees and the like which make the lease’s overall cost higher than what it first appeared to be.