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The Color of Money

Longer loans defy common sense

Email|Print|Single Page| Text size + By Michelle Singletary
May 7, 2006

It appears we've hit another consumer milestone, and it's not one we should be proud of either.

Last year, it was our savings rate. In 2005, for the first time since the Great Depression, the personal savings rate fell into negative territory.

This year, consumers have hit another landmark. The majority of auto loans are now five years or longer.

New vehicle loans over 60 months accounted for nearly 55 percent of loan originations, according to the Consumer Bankers Association's 2006 Automobile Finance Study. Used vehicle loans over 60 months accounted for 40 percent of originations.

In 2000, five-year-or-longer car loans comprised just 22 percent of all such lending.

Have people lost their financial minds?

''It is to a certain degree a sign that people are stretching," said Fritz Elmendorf, vice president of communications for the Consumer Bankers Association. ''It does raise the question of whether people are buying more car than they can afford and should they put the brakes on their car-buying behavior."

This trend is troubling because stretched-out auto loans have led to another milestone, an increase in the percentage of vehicle owners who are ''upside down" -- their loan balance is higher than the car's value.

That certainly is not good if you want to trade or privately sell your vehicle. Oh, and you'd better pray you don't get into an accident that totals the car. If you do, your insurance payment won't cover the loan.

In 2001, 25 percent of trades were upside down, according to data from the Power Information Network, a division of the marketing research firm J.D. Power and Associates. In 2005, 33.5 percent of car buyers owed more on their trades than the vehicles were worth.

I understand the temptation to take out a longer loan. The average new vehicle loan size increased by 4 percent to $23,534 from the year before, the association found. The average used vehicle loan increased 3 percent to $16,419. Those are the averages. Many people are spending far more.

Elmendorf gave another reason why loans are being drawn out.

''Fundamentally [consumers] are looking for monthly payments they can afford, even if it means adding a year onto their loan," he said.

While consumers may prefer longer loan terms, the survey showed that the lowest auto loan rates, about 5.5 percent, were available for terms of four years or less, compared with rates approaching 7 percent for loans longer than five years.

Recent data from Edmunds.com, an online resource for automotive information, showed 33.5 percent of car buyers had a loan term of 72 months. The average loan size was $26,156 with an interest rate of 9.6 percent.

Let's say you finance a car for $23,500 for 60 months at 7 percent. Your monthly payment is $465.33. At the end of that loan you would have paid about $4,420 in interest. Finance that same vehicle for 48 months at 5.5 percent and you will pay about $2,730 in interest. Your monthly payment is higher, $546.53, but you save $1,690 in interest.

If you need to keep your monthly payment around $465, get a less expensive car. Buy one in the $20,000 range, and you can have the monthly payment you want and you won't have to stretch your payments over five years. A $20,000 car loan for 48 months at 5.5 percent would get you a monthly payment of $465 and you only pay about $2,326 in interest.

Here's one gauge of auto affordability: 12 percent to 15 percent of after-tax monthly income is the maximum most people should pay monthly, according to Bankrate.com, which has an easy-to-use auto-loan calculator on its website. The site also has a calculator to help you figure out how much car you can afford based on your after-tax income.

Me, I've always kept my car payments under 10 percent of my net monthly pay. But then I hate being a debtor. The common definition of a debtor is one who owes a debt. But here's another one -- one guilty of neglect or violation of duty. I like the latter definition. When you get a loan for five, six, seven, or eight years on an asset that depreciates the second you drive it off the lot, it's accurate to say you're in violation of your duty to use common sense.

Michelle Singletary is a columnist for The Washington Post.

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