Consumers facing high asset prices and rising interest rates have limited and unappealing loan options. While it may be advisable for home or car buyers to wait, if they proceed, they often have to choose between accepting a large monthly payment or extending the loan term to reduce the monthly bill, a trend that many people are following. According to Edmunds, the percentage of new car loans lasting 73-84 months (over six years) increased from 28.6% in 2018 to 34.4% in 2022, with a small number of borrowers even opting for longer terms, including less than 1% of new car loans lasting 85 months or more.
Transportation affordability, as well as housing, is a significant problem. More dealerships are now offering extended loan terms to address this issue. The housing market is experiencing a similar trend, with mortgage lengths being increased to help people secure homes. Ultra-long loan terms are becoming more prevalent.
Homeowners with FHA mortgages can now extend their loans to 40 years, lowering monthly payments. Personal loans through LendingTree have also seen an increase in median term from 57 to 60 months in May. However, it’s important to exercise caution and avoid extending loans solely for short-term affordability, considering the potential benefits of securing a low rate for an appreciating asset like a 30-year mortgage.
Financial experts offer the following tips:
Calculate the total cost
Although a lower monthly payment may seem appealing, a longer-term loan will result in higher interest costs, often at a higher rate. Banks are more inclined towards these loans due to the additional risk. For instance, If you finance a $35,000 car over a period of five years with a 3% interest rate, the total payments would amount to $37,734. However, extending the financing to seven years at a 5% interest rate would increase the cost to $41,554, adding an extra $3,820.
Make tough decisions
If continually extending the loan term is necessary to afford an asset, it may be a sign to reassess the situation realistically.
Beware of negative equity
Extending loans increases the risk of having negative equity, where the amount owed on an asset surpasses its value. This is evident in both the car market and during housing downturns, such as the subprime mortgage crisis of 2007-2008. Consumers may find themselves in a situation where they owe money on a car they wish to trade in, leading to rolling that debt into the new car’s finance contract and paying interest on the debt twice.