As new car prices have risen, consumers have used longer payment periods to keep their monthly payments manageable. But that doesn't mean that they are keeping their loans – or their vehicles – longer.
TransUnion, the credit reporting agency, has completed a study that found the average term for new car loans rose from 62 months to 67 months from 2010 to 2015. But that's just the average.
Auto lenders now routinely make loans for six and seven years. After all, today's vehicles are better than they were a decade ago and studies have shown consumers drive their cars longer.
Yet the TransUnion study found that as loan terms got longer, the length of time a consumer continues to pay on the loan has gotten shorter. There could be several reasons for that.
Trading in before it's paid off
It's possible some consumers simply refinanced their auto loans at lower rates. But they could also have sold, or traded-in their vehicle before they finished paying for it. It is also possible that some vehicles were repossessed after the consumer defaulted on the loan.
TransUnion’s study found that car loan terms extending from 73 to 84 months have more than doubled between 2010 and 2015. In fact, 25% of all car loans in the third quarter of last year were for six to seven years, compared to just 10% five years earlier.
The danger of a long loan term is the slower pace at which the consumer gains equity. Vehicles lose value over time, meaning the consumer could be halfway through a seven year loan term and owe significantly more than the vehicle is worth.
“Consumers who cannot afford the monthly payment on a shorter term for the same loan are riskier, and we see this manifested in the higher delinquency rates for 72- and 84-month loans,” said Jason Laky, senior vice president and automotive business leader for TransUnion.
Even with smaller monthly payments, TransUnion found that consumers with longer loans are more likely to be 60 days or more delinquent on their car payments than consumers with shorter term loans.
While the 60 month, or five-year loan term has become something of an industry standard recently, personal finance experts still recommend a four year, or 48-month loan term.
They recommend the 20-4-10 rule to determine whether a new vehicle is affordable. If a consumer cannot make a 20% down payment, finance the vehicle for four years, and have the monthly payment not to exceed 10% of monthly income, then the vehicle is not affordable.