When I bought a car, it worked like this: First, I read a bunch of articles on the internet about cars to see what the good cars were. Then, I read some more articles on the internet about how much I should pay for a car given my income and debts. I combined my newfound knowledge of good cars with my newfound sense of financial responsibility to create a budget for myself and looked around on cars.com for stuff in my price range. I then started going to car dealerships to look at those cars, and discovered that they sucked and that what I really wanted was a Ford F-150 Raptor, a pickup truck that costs $80,000 and is designed to do jumps off sand dunes. After consulting my budget, I decided that buying an $80,000 truck was in fact not advisable for me or anyone else, but nonetheless elected to increase my budget a little bit just so I could hold out on getting something a little nicer than what I’d been looking at.
We all make these little mental deals with ourselves in some area of personal finance. Every person has something — cars, housing, vacations, a TV, a really nice pair of pants, whatever — where if they paid a little more, they would genuinely get way more use and/or enjoyment out of it to justify a jump in price.
Throughout the world, it is the job of salespeople to convince you that the thing they’re selling is that thing. But as I continued my search for a car, I discovered a frequent and disconcerting refrain from the salespeople I spoke with. Rather than asking what the overall price I wanted to pay was, they instead asked how much I wanted my monthly payment to be. Since most people get a loan for their vehicle anyway, we’re talking six of one, half-a-dozen of the other, right?
Not exactly. See, the total price of a vehicle is fairly static. Save for the possibility of knocking a thousand bucks or so off the sticker price during some last-minute haggling, cars cost what they cost. Shopping based on a monthly payment, meanwhile, opens you up to some very wacky upsells. If you wanted to pay $381 per month — the average monthly payment on a used car as of last year — you could take out a 36-month loan and buy something that cost about $13,000, or you could stretch your loan all the way out to 60 months and afford something around the $20,000 range (these prices assume you’re making a minimal down payment and being offered a low interest rate).
Typically, it’s advisable to take out a car loan of three to five years, so this is a perfectly reasonable — but already quite wide — price range. Now, once you’re checking out cars based on monthly payments, you’re already seeing what kinda cool stuff a longer term loan can get you, so what’s a couple dozen more months on top of that? A 72-month loan could get you a $25,000 car, and an 84-month loan can get you nearly $29,000. That’s used Ford Raptor territory.
This all seems really fine and great — again, the Ford Raptor can literally jump through the air — except for the fact that taking more than a 60-month loan is a really bad idea. Six or seven years is a long time, and committing to a sizable car payment for such a duration is incredibly risky. Your financial situation might change for the worse; you might have kids and discover you need something more practical; the car might be a nightmare to maintain; or it might just straight-up stop working. Then, you’ll have to trade it in and buy something else before you’ve fully paid it off.
The shorter the car loan term, the more likely it is that you’ll owe less on the car than what a dealer is offering you as a trade-in, and the remainder will get baked into your new purchase price as a discount. The more months you’ve got, the higher the chance becomes that the inverse will occur, and you’ll have to pay the remainder off, potentially by rolling it into your new car loan. Such a cycle of negative equity can create a snowball effect, yielding longer-term loans, higher monthly payments, and way more debt over time.
For many people, this isn’t a hypothetical. A new article in The Wall Street Journal reports that the average car loan term in America is now 69 months, and that “about a third of auto loans for new vehicles taken in the first half of 2019 had terms of longer than six years.” The WSJ adds, “A decade ago, that number was less than 10 percent.” Over that same period of time, the actual way car dealerships make money has changed, with sellers increasingly relying on selling car loans to their customers to generate profits — taking payouts from lenders or receiving a portion of interest payments — rather than selling the cars themselves.
All of this is adding up to a dire situation for car buyers. Per WSJ, “A third of new-car buyers who trade in their cars roll debt from old vehicles into their new loans, according to car-shopping site Edmunds. That is up from about a quarter before the financial crisis.”
As the automotive blog Jalopnik noted, this means that many consumers’ financial well-being could very well be in jeopardy if a recession were to hit. “Lost income and lost jobs makes it a lot harder for people to make the $500 a month payment they’re locked into for six years,” writes the site’s Patrick George.
Car loans are not as intertwined with capital markets as home loans were in the build-up to the 2008 financial crisis. From a macro perspective, that’s a good thing — if these risky car loans were to fail en masse, there’s less of a chance that they would take the entire economy down with them.
That hardly matters for the individuals who have been pressured into taking on car payments they might not be able to cover, of course. According to data from the New York Fed, nearly five percent of those with auto loans have failed to make a payment in 90 days. As the finance blog Credit Chronometer points out, that may create more pressure among lenders to give out even riskier loans in hopes of bringing in enough money to cover the losses of delinquent payments. That could mean longer loan terms, higher interest rates, and longer monthly payments — a cycle that could perpetuate until something really bad happens that we just haven’t foreseen. Or, if we’re all smart, it could mean we finally give up on expensive cars altogether.