You Go Upside-Down Instantly
Industry experts agree that cars lose 20% of their value as soon as you drive off the lot, which means the $25,000 car you just bought will be worth $20,000 by the time you hit the first traffic light.
When you get a long-term loan, it increases the chances of going upside-down on the loan.
The term ‘upside-down’ means that you owe more than the car’s resale value.
The longer the loan term, the harder it gets to build equity in the vehicle.
Unfortunately, more and more car buyers are opting for extended repayment terms only to find themselves upside-down immediately after purchasing the car.
This is a risky gamble, especially if you run into unforeseen financial hardships and can't afford payments.
Even if you try to sell the car, it won’t cover the outstanding balance.
You Are Starting A Negative Cycle Of Debt
A long-term loan sets you in a negative debt cycle. Let’s say you still owe the lender $10,000. However, the resale value of the car is just $5,000.
To clear the debt, you might want to trade-in the vehicle. The dealership agrees to pay-off this difference, however with a clause that they will roll this amount into the loan for your next car.
So, if you borrow $20,000 for the next car, this additional $5,000 gets added to the loan, and you have a total debt of $25,000.
This will increase your monthly repayments and the chances of financial hardships. Besides, the new loan will have additional negative equity when you calculate the 20% depreciation.
The higher the loan balance, the more the negative equity. And, each time this happens, your debt just increases.
Over 60 Months, Interest Rates Soar
According to financial analysts from Edmunds, consumers who opt for auto loans stretching beyond 60 months usually have to settle for higher rates of interest.
For short-term loans ranging between 48-60 months, the average rate is between 4.21% to 4.37%, but the same loan for terms ranging between 66 to 72 months and beyond leaps to around 6.6%.
For example, if you take a loan of $25,000 for 5 years at 4.1%, you’ll pay a total of $27,693.
That’s just $2,963 as interest over the life of the loan. But, the same amount for 6 years at 6.6% means you’ll pay $30,344 over the term of the loan.
Don't Forget Repairs, Maintenance, And Extra Interest
If you opt for a longer term, you’ll have to drive the same car for a longer time. As the car gets older, it’ll demand more maintenance and upkeep.
You’ll have to deal with unexpected repairs, regular change of brakes, tires, and engine fluids.
Basically, the cost of maintenance will keep rising with every mile travelled.
On average, the monthly repayment amount ranges around $550.
Depending on your financial situation, it can be difficult to maintain this amount while shelling out money for repairs.
You will also need to add to this the extra interest that you’ll end up paying for the extended term.
All in all, a long-term loan is only going to increase financial problems over the life of the loan.
Although long-term loans seem like a good deal at first glance, it is important that you consider all other aspects before choosing.
Extra interest, chances of going upside-down, falling into a negative equity cycle, unnecessary costs of maintenance, and upkeep; these can all lead to issues.
Now we have laid out the drawbacks of a long-term loan, take some time to figure out if this is what you really need.
Use online calculators to get an estimate of repayments for different terms, get multiple quotes from lenders, and then choose wisely.