Should you hitch a ride with a stretched-out car loan?
Americans today go a lot more miles on a gallon of gas than they did several years ago, but they're also taking out car loans that take a lot more months to repay. The payback time has hit a record length of five years, seven months for new cars and five years, two months for used, according to consumer credit firm Experian.
The lure of stretching out the loans is a lower monthly payment on cars that are increasingly expensive. Another startling number in the Experian report shows that loans of six to seven years now make up nearly 30 percent of the total.
But financial experts warn that if you opt for too long of an auto loan, you're risking debt problems or at least endless car payments. If you want to trade in your car within a few years, you may be "underwater," that is, finding out that your car is worth less than the loan payoff amount.
The temptation then is to roll the old loan into a new one for a new car. "Not only do buyers not have a down payment, they're adding the balance from their old loan," noted chief financial analyst Greg McBride of Bankrate.com. "It can be an endless cycle."
To avoid the pitfalls in these longer auto loans, follow these tips:
- Make as large a down payment as you can. Putting cash up front reduces the principal and the payments of the loan -- a much better option than stretching out its term. For used cars, put up at least 20 percent if you can, advised McBride. The same amount is ideal for new cars, but if you can't afford that, be sure to put at least 10 percent down.
- Don't take a loan longer than five years. Having a time limit helps you control your total spending. The longer the loan, the more you pay even at current very low rates (five-year loans now average 3.24 percent for new cars and 2.84 for used, according to Bankrate).
- Limit your auto expenses to 20 percent of your income. Make sure that your total auto costs, including fuel and maintenance, don't exceed 20 percent of your gross income, counsels auto website Edmunds.com. Remember with a newer car, your auto insurance payments will rise. Before starting to shop, try working out a budget with Edmunds' affordability calculator.
But in trying to limit those annual auto expenses, don't stretch out your car payments too much. "The goal is to get to life without car payments," said McBride. "Life without car payments is wonderful."
