Are You Following Clark’s Maximum Auto Loan Length Rule?

|
Happy couple in auto dealership talking to salesperson
Image Credit: Dreamstime

The average length of an auto loan in the U.S. is now 70.6 months and comes with a monthly payment of $573, according to the latest research.

Money expert Clark Howard says that’s nearly 30 months longer than any auto loan you should ever take out!

3 Reasons Why Long Auto Loans Are Bad News

With the coronavirus causing millions to become unemployed, automakers are struggling to find customers. That’s led more and more of them to turn to interest-free financing for as much as 84 months to lure potential buyers.

Seven-year loans are attractive to a lot of consumers because they let you stretch the length of your loan out to achieve a lower monthly payment. That’s why they’re often used by consumers with low credit scores.

But there are several drawbacks of longer loan terms.

They’re More Costly in the Long Run

With all the 84-month financing offers floating around, you might think you’re doing yourself a favor if you take a shorter term, say, a 72-month loan. That’s a scenario the Consumer Financial Protection Bureau (CFPB) examined recently.

But the reality is you’ll spend thousands more over the life of a six-year loan versus even just a five-year loan, according to the CFPB’s numbers.

Let’s say you finance $20,000 at 5% for five years. After three years, you’ll have paid $2,190.27 in interest and you’re left with a remaining balance of $8,602.98 to pay over 24 months.

But what if you extended that loan term with the same interest by just 12 months and took out a six-year loan instead?

After those same three years pass, you’ll have paid about $152 more in interest over 36 months, plus you’ll have a remaining balance of $10,747 to tackle over the next 36 months.

Advertisement

So the net effect of selecting a 72-month loan (instead of a 60-month loan) is that you’ll pay some $2,000 more over time!

You’re Likely to Finance More Money

“The average loan amount for a six-year loan was $25,300, compared to $20,100 for a five-year loan,” the CFPB writes. “The average size of loans with terms of seven years or more was even larger at $32,200.”

Keep in mind that right now — because of the unprecedented economic disruption accompanying the pandemic — money expert Clark Howard is warning consumers away from making most big purchases.

“Unless you are sitting there with tons of cash, you don’t want to be in a position where you’re taking on new debt obligations. I don’t care how good the deal is — and I’m the deal guy,” Clark says. “Don’t buy deals that would put you into debt.”

You’re More Likely to Default

As a general rule, the longer your loan term, the more likely you are to default on that loan.

Borrowers with six-year loans are about twice as likely to default than those with five-year loans, according to CFPB research.

Six-year borrowers have a more than 8% default rate, while five-year borrowers have a default rate in the neighborhood of 4%.

Keep in mind the CFPB did its research before the current pandemic, so we don’t know how the numbers look for seven-year loans.

But it’s probably safe to assume the rate of default will be even higher for those in the 84-month financing offers that are all the rage right now.

Clark: 42 Months Should Be Your Max Auto Loan

Clark Howard has long advised people that shorter is better when it comes to auto loan terms.

“The longest auto loan you should ever take out is 42 months,” Clark says. “If you can’t afford the payment on a 42-month loan, then you should buy a cheaper car.”

Buying a cheaper car may mean having to buy a used car instead of a new vehicle. But you might be surprised how much car you can get for not too much money.

Advertisement

Let’s take a look at the best used cars under $10,000, according to iSeeCars data:

Best Used Cars Under $10,000

Vehicle Average Used Car Price
2011 Toyota Prius $9,076
2012 Chevrolet Impala $9,240
2011 Honda Accord $9,363
2012 Honda Civic (Coupe) $9,406
2013 Mazda Mazda 6 $9,534
2012 Honda Civic (Sedan) $9,552
2012 Toyota Corolla $9,655

Final Thought

As you can see, there are multiple reasons why you should keep auto loan length to a minimum.

If the events of this pandemic have shown us anything, it’s that you never know when you’ll find yourself in a tough spot financially. So your best bet is to limit auto loans to 42 months or less — in both good times and bad ones.

Don’t Use Roadside Assistance Through Your Insurer!

Advertisement
  • Show Comments Hide Comments