The Four Year Plan

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Buying a car can be a pain. Trying to figure out how to finance it can be a nightmare. The reality is that shorter is better. The problem is that we want nicer cars and for the average person that means either bigger payments or longer loans.

I hate longer loans. You’re just trapped for a longer period of time.

Here’s a column I wrote for the Arizona Republic on what I called the Four Year Plan:

I’m a big fan of the four-year plan.

I worked hard to get out of college in four years, and I pay off my car loans in four years.

I mention this because there’s a disturbing trend in car loans these days: they’re getting longer. While four-year loans were once considered the maximum length, now six-year loans are becoming standard. According to the Consumer Banker’s Association 82% of new car loans last longer than four years. 31% of the loans last longer than five years. That means nearly a third of all the new car borrowers are locked into paying for that new car for six years or more.

And now the carmakers are jumping on board. Having sold lots of cars at zero percent interest, Ford and GM are searching for new buyers by offering six-year loans at 1.9% interest.
So why do I find this so disturbing? According to Bloomberg news, people who buy their car with a six year loan are more than twice as likely to default as people who buy it over five years. 2.1% of five-year loans don’t get paid off. 5.6% of six-year loans never make it.

A lot of people get those six-year loans because they can’t afford the higher payments of a shorter loan. It sometimes means that people who shouldn’t be buying new cars are wading into dangerous waters. But the lenders and the carmakers don’t really care. They know that they’re going to lose a certain percentage. It’s part of the cost of doing business. They don’t really care that 5.6% of those six-year buyers will end up with severely damaged credit.

Then there’s the “upside down” problem. Because new cars lose their value so quickly, you almost instantly owe more than the car is worth. As you make your payments, you eventually reach the break-even point. Up until that moment you are “upside down” in your loan. The longer your loan, the longer you stay upside down. If you are one of those rare people who keep a car more than six years, that’s great. But if you go to sell it after three years, you may discover that $15,000 car is worth $7,500, and you still owe nearly $8,000. If you destroy it in an accident you could be stuck paying for a car that you don’t own anymore.

So while the monthly payments may look appealing with a longer loan, think about how much you’ll like that car six years from now. That’s assuming you make it.

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