Car loan terms stretch as vehicle prices remain high

For a growing share of car buyers, paying for a vehicle is a seven-year commitment.

A record 22.9% of financed new-car purchases in the first quarter involved loans of at least 84 months, according to new data from car shopping and research site Edmunds. That’s up from 21.2% a year prior. A decade ago, it was 10%.

The average amount financed for new cars also reached a record high, climbing to $43,899 in the first quarter, up from $41,473 a year earlier, Edmunds data shows.

As the amount continues to climb, “consumers are having to work harder to make the numbers fit — a clear sign of how strained affordability has become,” said Jessica Caldwell, Edmunds’ head of insights.

The average sticker price on a new car in March reached $51,456, marking the 12th consecutive month that it’s been above $50,000, according to Kelley Blue Book. The average transaction price after incentives was $49,275, up 3.5% from a year earlier.

That amount is “reflective of a market that favors large, expensive vehicles,” said Erin Keating, an executive analyst for Cox Automotive.

The share of new-car buyers earning less than $100,000 was 37% last year, down from 50% in 2020, according to Cox Automotive.

Higher vehicle prices come as many households have been clobbered by ongoing high inflation that has yet to settle down to the Federal Reserve’s target of 2%. The consumer price index, a key inflation measure, rose 3.3% in March from a year earlier, according to the U.S. Bureau of Labor Statistics’ latest reading, released Friday. That’s up from 2.4% in February.

For car buyers whose budgets need to accommodate higher costs in many areas, stretching out their auto loan for as long as possible may be the only way to afford the payments, said Matt Schulz, chief consumer finance analyst at LendingTree.

“For a lot of people, it’s all about the monthly payment, but the extra cost for financing that car for seven full years is really high,” Schulz said.

“Generally speaking, a seven-year auto loan is something that you really need to think twice about because it’s so expensive,” Schulz said. “If the only way you can afford that vehicle is to finance it for seven years, it may be worth thinking about whether you may be buying a little too much car for you.”

To illustrate the cost of financing: A $43,899 loan at 6.9% — the average in the first quarter, Edmunds found — for 84 months would result in a monthly payment of $660 and would cost you $11,575 in interest over the full life of the loan, according to Bankrate’s auto loan calculator.

A five-year loan (60 months) at the same rate would mean paying $8,132 in interest over the life of the loan — $3,443 less. But the monthly payment would jump to $867.

If you don’t have good credit, the interest rate you’re charged is higher. By way of example: To finance that same amount ($43,899) for 84 months at 13.17% — a recent average rate for borrowers with a credit score of 501 to 600, according to Bankrate — the monthly payment would be $803, and the interest paid over the life of the loan would be $23,525.

And, typically, the longer the loan, the higher the interest rate, Schulz said.

Of course, other factors are considered in the lending decision, including your income, employment and existing debt, as well as how much of your income the monthly payments would eat up.

Because of how quickly new cars depreciate, Schulz said, there’s a risk of being “underwater” on your loan fairly quickly when you opt for a longer repayment term. That is, you owe more on the car than it’s worth, also known as negative equity. New cars typically lose about 20% of their value in the first year after purchase and about 55% over five years, according to Kelley Blue Book.

When consumers trade in a car with negative equity, that balance typically gets rolled into a loan for the new car. That larger balance can make it more likely that a buyer will choose a longer loan.

About a third of buyers owe more than their trade-in is worth and roll the remaining amount into the loan on their new car, according to JD Power. That share is similar to pre-pandemic behavior.

About 40.7% of new-vehicle purchases involving negative equity are now financed with 84-month loans, according to Edmunds data.