Driving our way into financial poverty with six-year car loans: Once a minority, six-year or longer auto loans now make up one third of all new loans.
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Taking on debt for buying a car is a risky proposition. Taking on subprime debt for buying a car is simply a bad financial decision. The subprime loan market is booming for auto loans. Cars can last longer, require basic maintenance, and typically run better than older models. That brings up challenges for the auto industry that needs people buying newer and more expensive models. But consumers always want the newest car or gadget so financing is the best way to get people to purchase an item. This is why the iPhone which would sell for $600 or more is usually bundled with a contract instead of the consumer paying for it all at once. You pay for it slowly over time. The same applies to car loans. However, the typical auto loan used to be 36 or 48 months. Now, we see 72 months and 84 months (6 or 7 years!) of car payments. This is such a bad financial move especially if you want to plan wisely for retirement. Taking on a depreciating asset is just not a good move especially with risky debt.
Subprime remerges with auto loans
The banking industry realizes that consumers only care about one thing and that is the monthly payment. That is why when the housing bubble was growing, many loans started focusing on lowering monthly payments via riskier mechanisms like interest only loans or others that deferred even interest for a future date. Loans for cars are now going on the same trajectory:
“(NPR) Six-year car loans used to be in the minority. They’re now the norm, and loans of seven or eight years are even becoming popular. New-car sales in the U.S. are booming, and longer car loans are playing a role. Nearly a third of new loans are now 74 months or longer.
But some worry the trend will hurt the auto industry in the future. Others worry it’s hurting consumers right now. Ed Kim, an analyst with AutoPacific, says one thing driving the trend is the cars themselves.”
The growth in subprime debt is coming from auto loans:
This debt is even worse than the debt in housing. At least a home is seen as an asset that typically appreciates over time. A car depreciates the instant you take it off the lot. The fact that auto loans of 72 months and higher make up one third of all new car loans is startling. People are still paying more but the monthly payment remains the same because people are tapped out and there is simply no wage growth.
You’ll notice from the chart above that new auto loans are booming. But a big part of the boom is coming from longer loans but also subprime debt:
People are consuming their future today and locking into big expenses by buying cars with risky debt. I would say a good rule of thumb is to not spend more than one-third your annual income on a car. That is, if you make $60,000 a year your upper limit should be $20,000. There are plenty of great used cars that you can get for that price or lower. Consumer advocates realize how nutty it is to take on long-term auto loans:
“Well, if we all had the luxury to take a 36- or 48-month term, but the bottom line is you know the average consumer just can’t afford that,” she says.
That reasoning drives consumer advocate Mike Sante nuts. He’s with Interest.com and says people on a budget are precisely the ones who shouldn’t be taking out long loans.
“They’re a way to get people into cars that are more expensive than they should really be buying,” he says. “It’s these kinds of decisions that you make, that will truly determine how much money you have later in life.”
Sound familiar? Someone buys a car today with a 72 month loan and they will be paying deep into 2021! And given that half the country is living paycheck to paycheck, the first priority should be on saving for the future not buying a car they can’t afford. Yet this is how we are pumping up our economy again by finding creative ways to finance big purchases. You also have many younger Americans financing their college education with student loans. The first thing many do once they are out is buy a car with a big loan. Instead of starting off on the correct financial footing, many are entering their first job in a negative net worth position. 6 year and 7 year auto loans make no sense and if you need to get a loan for this long of a period, you simply can’t afford that car.