New car loans stretch to greater lengths

When it comes to car loans, Philip Reed clearly wants to practice what he preaches. When he bought his first new car, a $15,700 Honda Fit, almost two years ago, Mr. Reed took out a five-year auto loan that can be paid off early – something he aims to do this year.

"Shorter is better" with loans, proclaims the man who is consumer advice editor at Edmunds.com in Santa Monica, Calif. Indeed, Reed considered a three-year loan term until learning he could repay the five-year loan early.

But increasingly, other car buyers seem less averse to debt. Even as fallout from the subprime mortgage fiasco ripples through the economy, data show available car-loan terms stretching out – even in a few cases, to as long as seven years or longer.

On the face of it, that could mean the loan might last longer than ownership of the car.

"It's crazy," says Julie Bandy, editor in chief of Bankrate.com in North Palm Beach, Fla. Since cars lose value quickly, "you could end up upside down" on a long car loan – meaning the car could be worth less than the outstanding loan on it when you try to sell or trade it in.

Consider some of the more striking trends in auto loan term lengths. On one hand, average durations have crept up modestly over the past five years, to almost 64 months in 2007, according to Edmunds.com. But according to J.D. Power & Associates, the largest percentage of new car loans obtained at the dealership – 41 percent – had durations of 72-77.9 months over January and February of this year. That's up 10 percentage points from the same period four years ago. Moreover, as of this January/February, 4.3 percent of loans from dealerships ran 84 months (seven years) to 89.9 months long, while 0.1 percent of the loans extended to between 96 months (eight years) and 101.9 months.

By comparison, the age of cars now being traded in at dealerships now average 5.8 years, according to Tom Libby, senior director of industry analysis at J.D. Power.

Experts link the elongating of loans to several converging factors: On the consumer side, experts point to rising car prices coupled with people's desire for fancier cars than perhaps they can afford. By obtaining a longer-term loan, buyers can trim their monthly payments, which can help them justify getting the car they want.

On the vendors' side, longer-term financing may help them sell cars, especially in today's troubled economy.

But for consumers, the longer loans aren't necessarily helpful. On the downside, for instance, they can delay the time they can afford to unload their vehicles.

According to Reed of Edmunds.com, they're "generally financed at a higher interest rate, which somewhat offsets the benefit of extending the loan."

Evidently, the longer loans haven't held down average monthly car payments either. Average payments climbed to $484.50 a month in 2007, up from $459.25 per month in 2002, according to Edmunds.com. Over that five-year period, car costs rose, boosting the amounts financed, while the average annual percentage rate on car loans stood at 7.37 percent last year, up 1.59 percentage points from 2002.

An increasing struggle to make the payments

Recent data also show a modest uptick in delinquent auto-loan payments. In last year's fourth quarter, 2.7 percent of automotive loans were 30 days delinquent, up from 2.55 percent at the end of the previous quarter, according to Experian Automotive, a unit of credit-reporting bureau Experian. It also said that 0.84 percent of automotive loans were 60 days delinquent in the last three months of 2007, versus 0.79 percent at the end of the third quarter.

To Experian Automotive, even those percentages are significant. Although "a delinquency rate of 2.7 percent may seem small, when compared with the overall auto-loan market of more than $800 billion, it still represents a substantial amount of at-risk dollars," says Melinda Zabritski, director of automotive credit for Experian Automotive.

The role of auto dealers

For their part, some financiers and others cite a competitive need to offer longer loans – but claim they're not hawking them.

Last August, Toyota Financial Services began offering 84-month loans, says spokesman Justin Leach, because other lenders had been doing so. Without a similar offering, "we lost a small number of our customers.... [So] we decided to offer 84-month loans to our better customers" – those "top-tier customers" with "better credit scores."

Still, Toyota "isn't pushing" the seven-year loans, he reports.

At Ford Motor Credit Co., 72 months is the "outer limit of our standard offerings," says spokeswoman Meredith Libbey. "Anything longer is very rare and done on an exceptional basis," although the company had undertaken a pilot program testing 84-month loans.

And at GMAC Financial Services, 84-month loans are "reserved for special individual cases. But as a rule, GMAC doesn't subscribe to 84-month loans," says spokesman Michael Stoller. Such loans "create a potentially dangerous situation for everyone involved," he explains.

How much longer can car loans be extended? While that issue remains debatable, some observers can't foresee them stretching much further. Given many people's desire to unload cars before their maintenance bills become too high, or their style too outmoded, some experts think 84 months may become a natural term limit, at least for the foreseeable future.

Moreover, the mounting interest in cars priced under $20,000, such as the Honda Fit, Toyota Yaris, or Nissan Versa, may have some impact. Purchasing such comparatively cheaper autos may curb some buyers' need for comparatively long car loans, some experts say.