One of my friends recently bought a brand-new Hyundai Sonata. I’m a sucker for a shiny toy as much as the next person, but I blanched when she told me how she got the car in the first place.
She took out a six-year loan.
She’s on a budget like everyone else and commutes about 70 or so miles round-trip each day for work. She needed something more substantial that would get her through those commutes comfortably and trouble-free. Her old car was a money pit and cost her a couple of workdays this year already.
Car loans these days stretch out to 6-8 years. They were unheard of until about 10 years ago. Now they’re the norm and the notion scares the hell out of me. Here’s why:
- Higher interest rates: the long-term car loans typically carry a higher interest rate. Very few people qualify for the Tier 1 0 percent financing that car dealers love to advertise, so be prepared to pay a higher interest rate.
- Negative equity: A new car depreciates about 22 percent during the first year. You’ll spend a good portion of that loan term “under water” or “upside down.”
- You’ll need a HUGE down payment to offset the negative equity and to somehow get ahead. Most average people (that’s us) don’t have the means to come up with a substantial down payment.
- Harder to recover from a total loss: whenever a car is totaled in an accident, the insurance payout is typically based on the car’s value at the time of the accident. The gap between the car’s value and the loan balance is the driver’s responsibility. It’s not pretty, even with a lower loan balance. A total loss can ruin you financially and leave you without a car if you don’t have the means to pay off the balance.
- Low resale/trade-in: most dealers are willing to take a car five years old as a trade-in if it’s in good shape. There’s still some equity in the car, but after years five and six, the value of the car drops considerably. Private party resale value will only be slightly better.
- You’re stuck: if you end up hating the car three years in and want to replace it, the remaining loan balance will be attached to the loan balance on the replacement car. You’ll be shackled to a car payment for much longer.
There are two key alternatives to the long-loan trap.
- Buy only what you can afford to pay off in five years tops. It may mean buying a smaller model or a lower trim line, but it beats being chained to car payments for six or more years.
- Buy used: there are deals to be had on used cars. You’ll pay less, face less depreciation, and can buy more car for the buck. Do your research and you could end up with a good deal on a pampered lease return or CPO car.
I get it. Easier said than done when sitting in a dealership surrounded by so many sparkling new cars. Who can resist? You can. Stand firm and don’t fall for the lower payment offered on a long-term loan. You’ll be able to afford not only a shiny toy, but also the accessories that will make that shiny toy uniquely yours.