Over the past 18 months, car buyers have become more willing to accept longer loans to afford a new car. As the average term of new auto loans has been lengthened, borrowers are being offered some of the most favorable terms the market has seen in a long time.
New data from LendingTree shows that most auto loans in the United States are for 72 months. 6 month loans are the second most common term. Financing of 72 months or more currently accounts for 43% of activity, up five points from 2020 and eight points from five years ago.
According to Dr. Cliff Robb, professor of consumer science at the University of Wisconsin-Madison, these durations last longer than the average length of time a driver typically owns a vehicle.
“The general idea is that people – after about five years – tend to want a new vehicle,” he said. Newsweek. “And that’s what makes these loans so attractive. You’re committing to a loan term that actually exceeds the typical term of ownership.”
Most consumers, he added, enter the buying process thinking they will drive a car until the wheels fall off. However, outside forces, such as the release of newer cars or someone close to buying a new car, often convince owners that they need to buy a newer car sooner than expected.
With years of financing still on the dealer’s ledger, drivers are heading to the dealer lots in search of a newer car.
“A lot of times you’re in a situation where your loan was more than the value of the vehicle,” Robb said. “So when you go to refinance, they’re just going to roll everything that was owed into the new loan. So you get even more of a backlog eventually.”
Tyson Jominy, vice president of data and analytics at JD Power, says ever longer auto loans are nothing new. “Long-term funding has been growing all our lives,” he explained to Newsweek.
But what’s really changing, he argues, is how consumers approach auto financing. Before the pandemic, 25% of new vehicle purchases were rentals. This figure currently stands at 20%.
Securing 60, 72, and 84 month term loans gives the average buyer lease-level monthly payments without any of the typical lease restrictions like mileage limits.
Many car dealerships today have less inventory to work with and many charge premiums on top of the Manufacturer’s Suggested Retail Price (MSRP). With less negotiation over cars with inflated prices, it feels like buyers don’t have many options they can control when purchasing a vehicle.
“Buyers have only one lever they can control in the buying process: term,” Jominy said. That’s what buyers do.
Robb says the circumstance is giving way to upselling at dealerships. A customer can support more options or a higher trim level if they have access to longer terms and, therefore, lower monthly payments.
Automakers are also noticing the trend, shipping high-quality options to dealerships unless alternatives are specially ordered.
He argues that consumers tend to focus on easier to understand information when dealing with the purchase of a vehicle. In this case, undereducated buyers inherently believe that a lower monthly payment is better.
“What we don’t always see is the fact that that lower monthly payment means that over the life of that automobile purchase, we’re paying way more than the vehicle is worth,” Robb said. “We often enter these contracts where we are already behind in terms of loan-to-value dynamics.”
A recent study by Credit Karma showed that 23% of respondents regretted buying a vehicle made within the previous six to eight months. The two main reasons given were that the purchase had set them back financially or that they were having trouble making the monthly payments.
For Robb and Jominy, this does not indicate automotive market conditions, but rather other factors.
“This may well indicate the broader pressure currently being exerted on consumers by rising costs and fiscal stress,” Robb said.
Jominy agreed, noting that there are far fewer subprime loans and leases going out right now compared to the run-up to the 2008 financial crisis.
Subprime loans are generally defined as high-interest loans given to people with bad credit, usually below a FICO score of 600. The 2008 crisis began after a wave of subprime loans hit the market mortgage has experienced arrears, causing a chain reaction affecting many segments of the economy, including auto sales.
Proving an effective way to move inventory at the height of the pandemic, these longer terms are here to stay, but Robb says longer-term loans serve as a powerful marketing tool for winning and retaining a customer.
“I think in the long run [dealers] are going to say, “wow, that’s a great way for us to sell more vehicles more easily,” Robb said. “It’s got all the selling points they like. The payouts stay low. They’ll refinance it for you later if you want to trade in. So considering all of those things, if the consumer just ignores the costs, it all sounds good. .
If you’re looking for a new car, there are pros and cons to 60 and 72 month (or longer) term loans. On the plus side, you can lower your monthly payment. On the negative side, you could end up paying more than the value of the car over the life of the loan. Experts agree that when financing a car, it’s important to think about the total cost of the vehicle, including insurance and maintenance, rather than just the initial cost.