The average car loan balance has grown by more than 15 percent since 2009 to nearly $20,500 in June 2015. According to Dennis Carlson, deputy chief economist at Equifax, generous financing terms, including low interest rates, smaller down payments and longer terms, combined with an improved economy, have enabled consumers to more easily purchase new automobiles.
“The cost of cars, both new and used, continues to rise,” Carlson says, adding that new safety features and innovative in-car technologies cost more to produce and add to the total price tag. “In the past, you used to find a new car for $12,000. It’s nearly impossible to buy a new car for that today.”
Rather than being discouraged by higher prices, consumers are finding ways to afford the vehicles they want, which Carlson says is a good sign for the state of the economy.
“People buy cars when things are both good today and look good tomorrow,” he says.
But when consumers take on these loans, they need to understand the full implications of their borrowing agreement.
Chasing a low monthly payment
“For many consumers their primary consideration is what they can afford on a monthly basis. They go into the process with a number in mind,” Carlson says.
Due to higher car prices, this has led to a rise in auto loan origination amounts—or the amount taken out when the loan begins—which has its own effects on consumer habits.
To afford a higher loan balance, consumers may choose a six or seven year loan, compared to the historically standard three or four year loan. They do so in order to lower their monthly payment, often without realizing how these lower payments can add up over time.
“Generally speaking, the fewer the amount of months, the lower the interest rate on the loan,” Carlson says. “When you start to get into longer terms, you’re likely going to pay a premium on interest.”
Even if the rate is the same, you are also paying more interest overall because you are paying the loan for more months than you otherwise would. For example, a $22,000 loan at 4 percent interest will cost you an extra $2,000 if you take out a seven-year loan instead of a three-year loan.
Better ways to keep your monthly payments low
While taking out a longer loan is one way to potentially lower your monthly payments, consumers can also try other methods to avoid the extra interest.
• Larger down payment. Saving more money upfront may take more time, but it can have long-term benefits. You can take out less money with a loan and potentially lower your monthly payments as well.
• Find a lower interest rate. Check your credit before you go shopping for a car loan so you can have an idea of where your credit strengths and weaknesses are.
• Buy a less expensive car. Simple, but true: If you have to take out a longer car loan in order to make the monthly payments for a car you want, you may want to consider finding a less expensive car that will still get you from point A to point B.
Dustin Pellegrini is a senior web producer and writer at Think Glink Media, where he specializes in reporting on identity protection and credit. He studied writing and visual media at Columbia College Chicago.
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