Many car buyers are flirting with danger. They are doing this by choosing longer duration loans when purchasing new automobiles.
This is based on recent reports by Experian and J.D. Power and Associates. Experian is a credit reporting agency. J.D. Power is an American-based global marketing information services firm.
During the fourth quarter of 2013, automobile loans with terms longer than six years (73 or more months) constituted 20.1 percent of all new vehicle loans. And the trend has extended into 2014. In February, a whopping 33.1 percent of loans were 72 months or longer in duration.
Why would new car purchasers extend payments for such a long period? The answer revolves around two interrelated factors.
First, the average amount financed by buyers has risen as new car prices have increased. The fourth quarter of 2013 witnessed the greatest amount financed – an average of $27,430 – since 2008.
And this February the transaction price was $32,319 – 2 percent higher than one year earlier – according to Kelley Blue Book, an automotive vehicle valuation company. The transaction price is defined as what the customer actually paid for a vehicle.
The second factor involves the psychology of typical automobile buyers. Most tend to look at monthly payments instead of the amount financed or the total cost including finance charges. And many automobile dealers are helping to encourage the trend by getting buyers to focus only on the monthly payment.
Most industry analysts recommend that buyers limit the length of a car loan to 48 months with a down payment of 20 percent. In many cases, this means purchasers may need to consider a lower-priced automobile to stay within these guidelines.
Long-term loans may seem to make more expensive cars seem affordable, but it is merely a costly illusion. This type of thinking leaves buyers with higher overall costs. And toward the end of the term, they are surprised that they are “upside down” on the loan. That is, they owe more on the automobile than its current value.
This is a case study for why the American people need to be financially literate. Unfortunately, many citizens do not understand the basics of personal finance. And many learn the hard way that lack of literacy can be extremely expensive.
Wayne Curtis, Ph.D., is a former superintendent of Alabama banks and Troy University business school dean. He is retired from the board of directors of First United Security Bank. Email him at firstname.lastname@example.org.