Recent statistics indicate that about one out of every six car loans now run 73 months or longer – all the way up to 97 months.
The shift is part of a collective effort by car companies to keep monthly payments below $500 at a time when the price of an average new car price has risen to well above $30,000. But from a consumer standpoint, let’s discuss the impact of longer car loan terms on your finances, and in particular the 97 month car loan (that’s eight years and one month).
Should you even consider a 97-month car loan?
The primary and most obvious benefit of a 97-month car loan is in keeping the monthly payment to an absolute minimum. This is the effect of stretching the payment out over the longest possible term. A $25,000 loan for 97 months at 4% will be $302 per month. This looks seriously attractive when you consider that the same loan over 60 months will require $460 per month.
But is that as good a deal as it looks? Here are some facts to consider:
1. The car will depreciate faster than the loan will amortize.
One of the biggest risks with long term car loans is that the value of the car will drop faster than the loan will amortize. According to Cars Direct, new cars typically depreciate by 20% as soon as you drive them off the lot, then at a rate of about 15% per year for the first five years (after that they depreciate at much lower rates).
Let’s use those rates in connection with a brand new car bought for $30,000 with a $25,000 loan spread over 97 months.
After two years, the loan will be paid down to $19,544.
But the car will drop even lower. It will lose $6,000 as a result of the 20% loss from driving it off the lot – to $24,000 – then by 15% in each year. That will drop the value of the car to approximately $17,340 after the first two years. That’s means that you will be “upside down” (negative equity) on the car to the tune of about $2,200 just two years in.
That status will continue for the first few years of the loan, making it impossible to either sell or trade the vehicle for another.
2. A longer loan term means you’ll pay more money in interest.
An important point that is often missed when it comes to loan terms is the fact that you will pay more interest the longer the loan term is. Continuing our example of a $25,000 loan at 4%, you’ll pay a total of $2,625 in interest over the course of a 60-month loan. But if you extend the term to 97 months, you will pay approximately $4,300 over the life of the loan.
What that means is that you will pay nearly $1,700 extra for the same car as a result of taking a longer loan term. Sure, your monthly payment may be lower, but you will pay more in the long run. And interest on car loans is not deductible for income tax purposes!
3. You’ll likely need a major car repair or two before the loan is paid.
There is a tangible reason for the widespread popularity of 48 and 60-month car loans. A car purchased new can generally be expected to go for about four or five years before needing significant repairs. But once you go beyond five years, not only do repairs become more frequent, but they also become more costly.
At that point, you will begin needing to replace major components of the car. And you may even find that you will need to make some heavyweight repairs, such as replacing the transmission, as you approach the eight-year mark. Once again, the long-term cost of operating the vehicle will rise as a result of needing to keep the car longer.
4. Your job might not last as long as the loan.
I think most people understand that job security doesn’t exist in most career fields. Five years is a long run on a job – how does that match up against an eight-year car loan?
Now we can say that you can simply get another job; in fact, it is entirely possible that you will have several jobs over the life of the loan. But there is no guarantee that subsequent jobs will pay as much as the one that you had when you first took the loan.
With a 97-month car loan, you may be committing yourself to a monthly payment that will last longer than your income level will.
5. You will most likely replace the car before it is paid off.
Whether it is motivated by the loss of a job, a run of costly repairs, or simply the desire to have a new car, there is an outstanding chance that you will want to replace your car before the 97-month loan is paid off. If that is the case, then you’ll have to do so with less trade-in equity than you would have if you had taken a shorter loan term. It is even possible to have no equity – or even negative equity – in the vehicle at all if you decide to make the buy within the first five years.
When buying a car, understand that it’s not all about the monthly payment, as car dealers like to insist. A low payment could set you up for other problems – big ones – later on.
Would you consider buying with a 97-month car loan? Can you see any other advantages or disadvantages that I haven’t included? Leave a comment!