With the average cost of a new vehicle now around $30,000, it's no surprise that car loans are getting longer and longer, notes Consumer Reports. Some banks now offer car loans with payback terms that run for as long as eight years. While long-term loans translate into lower monthly payments, they can cost you in other ways.
Higher interest, higher risk
A longer loan means higher interest costs. That's because you're making payments for a longer period of time, and longer loans often have higher rates.
To find out how much more you might pay, staffers at the Consumer Reports Money Adviser newsletter calculated the difference between 48-month and 72-month loans on a $32,765 car, with a negotiated price of $30,520. The longer loan will cost you about $1,600 more, assuming a 10 percent down payment. If you put 0 percent down, the difference climbs to more than $1,800.
And longer-term loans are more risky. That's because cars depreciate over time, with the quickest loss in the early months. So unless you make a substantial down payment or have a high-value trade-in, your new vehicle initially will lose value faster than you're paying for it.
Owing more than the car is worth is known as being upside down. At some point as you pay off the loan, you'll no longer be upside down and will begin building equity in the vehicle. But the longer the loan, the longer it takes for that to happen.
The catch with leases
Another way people lower their monthly payments is by leasing. But if you think that makes leasing less costly, Consumer Reports urges you to think again.
The first thing you should understand about leases is that whether you acquire the vehicle with a loan or a lease, you're borrowing the entire value of the vehicle, minus any down payment or trade-in. And you'll be charged monthly interest on that amount reduced by what you pay back along the way. There's the rub.
With leasing, instead of paying off the whole car, payments are based only on projected depreciation.
So over a 48-month lease, instead of paying off the entire net cost of the vehicle, you'd pay back only about half, which results in much lower monthly payments. And because you'd be paying back less, that leaves a greater amount subject to a finance charge month after month. It's true that you'll lay out much less cash, but with a loan you get to keep the car. And if you take into account its value, the loan typically ends up costing less.
The biggest saving grace for leasing is the sales tax break you get in most states compared with buying the car. In most states, leasing customers pay tax on the monthly payment instead of on the entire cost of the car.