On the road and in the red
Higher prices and longer loans are pushing new-car buyers into a debt spiral. Here's how to climb out.
It sounds like a great deal: Buy a car and finance it for five, six, or even seven years. Payments are smaller. You can buy more car. And automakers and banks make it easy to do.
So what's the hitch? Long-term debt.
By not paying off their loans fast enough, car owners run two financial risks down the road. They could end up still owing money on their old car when they go to buy a new one. Worse, they might owe more on their vehicle than it is worth.
Such problems have become more pronounced as the price of new cars has risen - to more than $25,000 on average last year - and auto companies have eased credit terms to keep cars moving off the lot.
"It's a vicious cycle," says Peter Humleker, a former auto dealer and now consumer advocate and author of the e-book "Car Buying Scams." "Consumers just keep digging themselves a bigger, deeper hole."
The only way out is to buy a less expensive car or to hang onto the old one until it's paid off, says Rob Gentile, head of the car-buying service at Consumer Reports.
Last week, Warner Smith bought a 2004 Honda Civic to commute to his computer-networking job in Elgin, Ill. Looking for low payments, he signed up for a five-year, 2.9 percent loan. Since the interest rate was no lower for shorter-term loans, Mr. Smith decided to go long term with payments just under $300 a month. But "I'm keeping my options open," he says. He's now considering forking out $370 each month to pay off the loan in three years - a route some financing experts say is worthwhile.
By accepting longer loan terms, more and more consumers end up buying new cars while still making payments on their old ones. In 2004, 38 percent of shoppers who bought a new car on credit still owed an average of $3,686 on their trade-in, according to Edmunds.com, a consumer car-buying guide in Santa Monica, Calif. As a result, the money they owed on their trade-in was often rolled into the payments on the new car.
By signing up for long-term financing, "you're making a commitment that you're keeping this car around quite some time," says Mr. Gentile.
Nevertheless, after a few years, many buyers' financial situation or automotive needs have changed, experts say. Others, still in debt after the warranty expires, face big repair bills on top of monthly car payments.
At the root of the phenomenon is the easy credit that dealers and bankers have been offering for car loans.
After 9/11, automakers raced to shore up sales with zero percent financing and big cash incentives. Thezero interest loans were offered mostly over periods of three years or less. Only buyers with solid credit records qualified. Rates for longer-term loans were higher.
Now, the average new-car loan runs 62 months, up from 50 months in 2001, according to a recent Power Information Network (PIN) survey, an affiliate of J.D. Power and Associates.
"The terms of the transaction are all working to make the [consumer's] financial situation worse," says Tom Libby, a PIN analyst in Troy, Mich.
One other problem: Cars are depreciating faster because dealers are slapping discounts on new models. Those discounts averaged $2,367 last month, down from last July's record, but still historically high, according to Edmunds.com. Because the market is flooded with new cars, the market for used models has shriveled.
Even without accelerated depreciation, a seven-year loan encourages buyers to pay off their cars more slowly than they depreciate. Owing more for a car than it is worth is known in the industry as being financially "upside down." (Bankers call it being "under water.") To make matters worse, longer loan terms often come with a higher interest rate. Rolling money owed on a trade-in into a new-car loan raises that rate further.
Many buyers who opt for long-term loans have little cash for down payments. "In reality, they're trying to buy more car than they can afford," says Phil Reed, Edmunds.com's consumer-advice editor and author of "Strategies for Smart Car Buyers." "Many car-shoppers today are making the mistake of thinking in terms of monthly payments rather than total cost."
Automakers say loans that last more than five years represent a small part of their business and are targeted at buyers of expensive "specialty" vehicles, such as conversion vans. At General Motors Acceptance Corp., GM's finance arm, only 1 percent of vehicles are financed for longer than 60 months.
Page: 1 | 2 
