Are you thinking about buying a new or used car? If you plan to get a loan to finance your purchase (especially if it’s through the dealership itself), then be careful. Many of them will try to steer you into the longest loan they can … the 84-month loan.
For years, a 60-month auto loan was considered the industry norm (much like how a 30-year mortgage is normal for home buying). But in the past decade, things have begun to change. According to Nerd Wallet, 38 percent of new-car buyers took out loans between 61 to 72 months, and an alarming 32 percent signed up for loans that carried a term between 73 and 84 months.
Why is that a big deal? For a LOT of reasons. Here’s why an 84-month auto loan is just an all-around bad idea.
It’s a Sneaky Sales Trick
You probably didn’t see this coming, but longer-term loans weren’t designed because they’re helpful or better financially. Nope, they were created for one reason only – to sell more vehicles!
Suppose you come to my dealership and you see a car that you really want. If I’m a salesman, what’s going to be the easiest way to get you to buy this car? By telling you it costs almost $600 per month, or just over $400?
Obviously, for the average consumer, the lower price is going to work every time. They won’t think about the fact that they’ll have to make payments for an extra 24 months. They’ll just hear the lower number and impulsively agree to it.
Dealerships know this, and these types of loans are their sneaky way of playing into our psychological limitations. By making the payments appear smaller, they know it will be that much easier to talk you into signing that dotted line.
Your Vehicle Probably Won’t Even Last that Long
There’s a good reason why auto loans have classically been 60 months: Because that’s historically been about how long you’ll want to keep your vehicle.
While most vehicles are rated to last up to 150,000 miles (or around 8 years, keep in mind that’s only if it’s been properly maintained and driven less than approximately 20,000 miles per year. Unfortunately, the general public doesn’t do either of these things, and that means there’s a good chance they’ll be looking to trade up long before 84 months.
This situation is even worse news if you buy a used vehicle. Consider if you buy one that already has between 50,000 and 100,000 miles on it. Unless you plan to drive this vehicle until it breathes its last breath of air, the loan will likely outlive the vehicle.
You’ll Pay a Higher Interest Rate
A lot of people don’t realize this, but anytime you opt for a loan that’s longer than 60 months, you’re going to pay a higher interest rate. Generally, you can expect to pay another 0.5 to 1.0 percent higher than what you would normally.
This is because the lender knows that a higher interest rate will effectively be hidden from most people since the overall monthly payment will be lower on an 84-month loan. Therefore, they’re effectively charging you for the convenience of having the lowest payment option possible.
You’ll Pay More Interest Over Time
You don’t have to crunch the numbers on a loan with a longer term to know that you’re going to end up paying more over the life of the loan. But just in case, we crunched them anyways.
Using a free online car payment calculator from Google, an auto loan of $30,000 would cost:
- $569 per month for 60 months at 4.5% APR = $4,169 in total interest paid
- $493 per month for 72 months at 5.0% APR = $5,463 in total interest paid
- $432 per month for 84 months at 5.0% APR = $6,292 in total interest paid
See the difference in interest between a 60- and 84-month loan? Now ask yourself: Is it really worth paying an extra $2,123 just so you can have a lower payment each month?
You’ll Be Underwater on Your Loan
Vehicles are notorious for depreciating in value at a rapid rate. Especially in the first five years, the resale value of a car can drop by as much as 60 percent of what you paid for it brand new. Ouch!
This can create a problem for your loan. Normally, when you pay off your auto loan, you’re slowly building equity – meaning that you effectively own a higher percentage of the vehicle until the entire loan is paid back in full. But if the physical vehicle is actually worth less than what you owe, then you’re what they call “underwater”.
For example, let’s say that you bought you financed a new vehicle for $30,000 over 84 months. After 3 years of paying the loan back, you might have only paid back roughly $15,000 of that loan and still owe almost $28,000 in principal and interest. However, if the vehicle gets totaled or you need to trade it in, you might only get $20,000 leaving you approximately $8,000 in the hole.
Sticking to a loan with a shorter term will help ensure that the payment schedule is better aligned with the actual value of the vehicle as it depreciates.
What You Should Do Instead
I get it – you need a vehicle. It’s what gets you to work and lets you do errands, and there’s a good chance you probably don’t have tens of thousands of dollars lying around to pay for one with cash and avoid a loan altogether.
That’s okay – not all loans are bad. As long as you pick the one that has the best options for you, then they can be a really helpful way to buy the things you need.
Here’s what you can do to keep your auto loan under control:
Set a Budget
Buying a vehicle is no different than buying anything else. You should only buy what you can afford. Even if you plan to finance your purchase, don’t get suckered into getting something that’s way outside of your price range. Decide up front how much you’d like to spend and stick to it.
If you’re not budgeting already, then try an app like Buxfer. Buxfer connects to all of your bank accounts and financial institutions so that you’ll always have a real-time report of all your transactions.
Buy Used
Again, vehicles are known to depreciate in value rapidly within their first few years. While that can be bad for a loan, it can be useful if you’re strategic about your purchase. The next time you’re in the market for a new ride, strongly consider buying one that’s in great shape and only 3-4 years old. You’ll pay almost half what it would have cost brand new which will give you more bang for your buck.
Look Into Leasing Options
Depending on the type of vehicle you want and what kind of deals are being offered, it’s totally possible that leasing might be a cheaper option over buying. Ask for the facts upfront and make sure you understand all of the details about a potential lease. Come up with an estimate about what the total out-of-pocket cost will be compared to a regular purchase.
Final Thoughts
Don’t be tricked into an 84-month loan just because the payments will be cheaper. Look for a vehicle that’s reasonably priced, and don’t spend any more than you need to. Keep these tips in mind, and it will make driving that new ride that much more enjoyable.
Source: Pexels
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