While extending the length of an auto loan could make it easier for you to afford the monthly payments, it might not be the best financial decision regardless of your credit score.
What Should the Length Be of an Auto Loan?
Unfortunately, if you have bad credit this might not be feasible. The monthly payments might be more than you can comfortably afford. Your subpar credit score also means that you will probably have to come up with a sizeable down payment.
According to data compiled by Edmunds, over 60 percent of the approved auto loans in 2014 were longer than the recommended 5 years. Even though more Americans are accepting the terms of a lengthy car loan, the majority are still not considering the potential risks.
Risks of a Long Bad Credit Auto Loan
If you have bad credit and are approved for an auto loan, it will probably come with high interest rates. This means higher monthly payments on traditional 60 month auto loans. Having a sizeable down payment can help lower monthly payments, but many consumers with bad credit do not have the extra cash.
This is when you might start to consider a 72 month or longer bad credit car loan. Since the payments are stretched out over 6 years or more, you will pay less each month. This still applies even if you are approved for a car loan with no down payment. For many consumers this can seem like a financially attractive option, but a lengthy bad credit auto loan also comes with several risks.
You will pay more in interest.
Longer vehicle loans might seem like a good decision if you have bad credit, and are worried about high monthly payments.
In 2014 interest rates on a 60-month car loan averaged around 2.41 percent, compared to an estimated 5.9 percent on one lasting 72 months. If you have subpar credit the interest rates will probably be significantly higher.
It is not uncommon for consumers to learn that they are paying three times the interest or more on an auto loan with longer terms. This means that overall, they are paying more for the vehicle than someone with a short-term auto loan.
The vehicle will lose equity.
Automobiles typically depreciate around 22 percent in the first year, and this usually means that you will be “upside down” on the auto loan before you even sign the agreement. How long it takes to get “right side up” will depend on the size of the down payment.
Without equity in the vehicle you won’t be able to sell it for a profit if you suddenly find that you need emergency cash. Potential car buyers will only pay the Kelley Blue Book value or less, leaving you responsible for the remainder still owed on the loan. The lack of equity can also be a problem if the vehicle is totaled in an accident. Insurance companies will only pay what the automobile is worth, not the amount owed on the car loan.
Car “fatigue” can be a problem.
On average, car buyers are usually ready to trade their vehicles in after 6 years. The fascination with the new car has worn off, and they are ready to see what the latest models have to offer.
With a standard 60-month car loan this usually won’t be a problem, since the potential buyer has built up some equity in their current vehicle. They can usually use it as part or all their down payment towards their next new car. This can help make their next vehicle a little more affordable.
You do want to avoid rolling the balance of one auto loan onto another, though this probably won’t be an option if you have bad credit. Not only will this extend the terms of the loan even longer, you will also be paying more in interest rates. It will also have a negative effect on your credit score that will be difficult to repair.
The resale value will drop.
A vehicle’s age is one of the main factors in determining its resale value. Ideally, you want the vehicle to be worth more than the loan when it is finally paid off. If you owe more than the vehicle’s worth, it’s referred to as an “upside auto loan”.
This is one of the main reasons financial experts recommend avoiding long term auto loans. If you are stuck in a 6 or 7 year bad credit auto loan, by the time you are ready to trade it in you will only receive a fraction of what you paid to apply towards a new vehicle.
Vehicles over five years are often not approved for dealerships’ Certified Pre-Owned Process (CPO), and this can further decrease their trade-in value. There is also the risk of the dealership refusing the vehicle completely due to its age. This could limit your options to a Buy Here Pay Here lot that accepts older model vehicles as trade-ins.
You Have Other Options
You can avoid the risks that come with lengthy auto loans, and still get the vehicle you need.
While being able to afford larger monthly payments is the best way to shorten the terms of the auto loan, this might not be possible for everyone. You might also want to consider purchasing a used vehicle. Even though the interest rates are usually higher, there will be less to finance so you will still have the low monthly payments you need.
Financing a 5 year used car auto loan has the added benefit of helping to improve your credit score, as long as you keep up with the monthly payments.
Before you accept the terms of any auto loan, regardless of its length, it is important to read it carefully so you know exactly what you are paying for the vehicle.