New car and truck loans have ballooned to an average of 5 1/2 years from four to five years not long ago, allowing buyers to afford more expensive vehicles and fulfill their urge to drive the newest thing now.
Auto industry analysts say that longer term auto loans — some for seven years or longer — have helped fuel robust growth in new car sales.
Car shoppers who can afford $320 a month can get into a 2015 Ford Fiesta SE hatchback with 10 percent down on a four-year loan at 1.9 percent. But put 10 percent down on a 2015 Ford Fusion SE and you can get a bigger car for just $358 a month when you finance over six years at 4.9 percent.
But the increasing prevalence of the six-year-plus terms has led some industry observers to question the practice. With a seven-year car note your baby in the back seat will be well into elementary school when the vehicle is paid off.
And while the average car on the road in the U.S. is more than 11 years old and quality is improving, consumer advocates remind buyers to do financial research and weigh options and preferences before signing on the dotted line on a lengthy loan.
Michael Logue, a business operations manager from Castle Rock, Colo., and his daughter Shaylee Smith are using a six-year loan to finance a 2014 Mini Countryman S “with all the bells and whistles.”
With a price tag of about $38,000, Logue, 50, and Smith, 26, financed the car this spring under a 72-month term.
“It was due to the cost, to keep the monthly payments at a reasonable level,” he said in a telephone interview. “This was kind of my daughter’s dream car.”
Logue said payments are about $650 a month and he is expecting his daughter will drive the car for 10 years or longer.
Several automakers this month are dangling zero-percent financing for 72 months, including Ford Motor Co. and General Motors Co.’s Chevrolet brand, which also is advertising no payments for 90 days. Chrysler Group LLC is offering zero-percent financing for 72 months or 60 months on some vehicles, and has a 90-day no-payments offer. Toyota Motor Corp. and GM’s Buick brand offer zero-percent for 60 months on some cars.
It’s not uncommon for some dealers to offer buyers 96-month financing — that’s eight years to pay off a car. Nearly a quarter of loans are for longer than six years and up to seven years.
Morgan Stanley auto analyst Adam Jonas sees a problem with record auto loan terms and average transaction prices. High prices are fueling automaker and finance company profits, but Jonas thinks the phenomenon is borrowing demand from the future. Car buyers think they can afford a bigger car given low interest rates and longer terms, so they’re opting for the “tech package with all-wheel drive and luxury interior,” Jonas said.
“It gives the optics of improved pricing and volume, when all you’ve done is pulled forward profit from the future,” he said in a telephone interview.
Some automakers such as American Honda Motor Co. Inc. frown on resorting to hikes in subprime lending and 72-month loan terms to increase sales. John Mendel, executive vice president of the automobile sales division for American Honda, said Honda has no plans or desire to follow those approaches, yet remains on track to hit all-time record sales in the U.S. this year.
Auto loans hit $905B
The U.S. auto industry is on pace to sell about 16.5 million cars, trucks and SUVs this year, up substantially from the 10.4 million in 2009 during the Great Recession. Jonas expects the hot sales trend to continue for the next few years with the help of lower interest rates, extended loan terms and hard-to-pass-up lease deals.
Jonas expects automakers to sell 17 million vehicles in 2015 and 18 million by 2017. But he predicts sales will fall 22 percent to 14 million in 2019.
The analyst said a lot of people disagree with his prediction. “We’re raising questions,” he said. “We’ve been getting tremendous amount of pushback.”
Auto loan originations hit their highest level in eight years in the second quarter of this year. Auto loan balances have gone up for 13 straight quarters, hitting $905 billion in the second quarter, according to a report released last week by the Federal Reserve Bank of New York.
Experian Automotive says the average auto loan is now 66 months, and 1 in 4 new-car loans in the first quarter were for 73-84 months, up 27.6 percent from first-quarter 2013. Buyers are financing bigger notes than ever, with the average in the first quarter hitting a record $27,612, up nearly $1,000 from a year earlier, the company says. The average monthly payment for a new-vehicle loan was a record $474 in the first quarter, up from $459 in the same quarter in 2013.
“I don’t expect to see any of those decrease,” Melinda Zabritski, Experian Automotive’s senior director of automotive finance, said in an interview.
Edmunds.com also says the average new-auto loan in July was for a record 67 months.
Zabritski said vehicle prices, amount financed and terms will continue to rise, in part to pay for changes that automakers must make meet more stringent fuel efficiency standards.
She predicts we’ll see fewer five-year auto loans and more six-year and longer loans. “Especially as interest rates begin to rise, we’ll see more of that,” she said.
Buying cycle extended
At some point, experts believe automakers and lenders will cap how long they’ll extend loans. The big question is when.
Steven Szakaly, chief economist for the National Automobile Dealers Association, said he isn’t concerned with the length of auto loans, given the average age of cars on the road today — more than 11 years.
“People have tended to have taken out loans for half that useful age of the car,” he said in a telephone interview, adding he would be concerned if car payments continue after a car’s useful life.
Buyers are taking advantage of low interest rates to get something a bit more expensive and pay for it over time, Szakaly said.
But, he notes, the longer the loan term, the longer the buying cycle. And that can affect sales for dealers and automakers down the road.
The average rate on a 60-month new car loan is 3.18 percent, according to Bankrate.com, a financial information website.
Szakaly predicts auto interest rates will go up, but he predicts a stable, steady increase. “Over the next two years, we’re going to see interest rates rise for sure,” he said.
Consumer finance experts such as Katie Moore, a certified consumer credit counselor for GreenPath Debt Solutions, recommends that consumers in most cases not exceed five years on an auto loan.
Moore said buyers are oversold at dealerships “all the time” as they fall in love with their dream car and take out a longer loan to pay it. She reminds buyers to think about vehicle depreciation and to consider whether they might want a new car in five years. If so, she says a seven-year loan might not be the best choice.
Moore encourages those thinking about buying a new car to figure out what the monthly payment would be, plus insurance. They then should put aside that amount for a few months to see how well they’d be able to handle the outflow. She recommends a down payment.
Philip Reed, senior consumer advice editor at Edmunds.com, suggests that those buying a new car should finance for five years, with 20 percent down to prepay vehicle depreciation. If buying a used car, Edmunds.com recommends three-year financing.
Reed’s rough guideline is that car payments should not exceed 20 percent of take-home pay. His thought on a seven-year loan? Forget about it. Often with those longer-term loans, the interest rate is higher.
“We don’t like seeing loan terms stretched and people encouraged to borrow for long periods of time, because the future is uncertain,” he said.