Car buyers look to long-term payoffs

By John Eckberg

Critics fear plan will backfire on dealers

Nicole Heitman of Deer Park did not hesitate this week to commit to paying off her new Chevrolet Cobalt SS coupe over six years.

Heitman, 21, calculated that by trading in her 2005 Tucson SUV for the brand-new coupe, she could not only get better gas mileage but also wipe out debt, since she owed more on the loan than the Tucson was worth.

“I turned around a lot of negative equity,” Heitman said. “I saw no downside, and even if I didn’t have that zero-percent financing, I would have gotten a 72-month loan. I’m planning on keeping this car for a long time.”

Higher interest rates, pricier cars and consumers seeking lower monthly payments mean a growing number of people are taking six or even seven years to pay off their dream cars – with or without manufacturers’ incentives such as zero-percent financing, a year’s worth of free gasoline or rebates.

Longer loans are a trend in the car-buying industry that some say could backfire and bring Greater Cincinnati and Northern Kentucky car buyers – and dealers – sleepless nights years from now. Buyers could find that vehicles bought today are worth less than whatever is owed on the loan, and dealers may have fewer new-car buyers in their showrooms in the years to come as people struggle to pay off the longer-term loans.

“Household budgets are tight,” said Greg McBride, senior financial analyst for Bankrate.com, a personal finance Web site based in North Palm Beach, Fla. “One way car buyers keep their payments low, especially when buying bigger cars, is to stretch the term of the loan. What happens with longer car loans is that the balance declines at a snail’s pace while the value of the car declines much faster.”

Experts call that upside-down equity: The residual value of the car – after years of monthly payments – toward the end of the loan is less than how much the buyer still owes. And it’s becoming more frequent: The National Auto Dealers Association reports that long-term loans of four years or more have increased from about 10 percent of the market in 2002 to nearly a third of the market today. In 1999, the average number of months for a car loan was 53 and by 2005, it had grown to 60 months, according to Bankrate.com. Most cars in 1971 were financed with a 38-month loan.

So what’s the upside to long-term auto loans?

Car dealers like them because rising interest rates are pushing up buyers’ costs, so paying off a car over three or four years brings monthly payments beyond the budget of most middle-class households. Also, long-term loans help the dealers sell cars now, not in six months.

Finance companies like long-term car loans because borrowers are more likely to keep their cars for the full term of the loan, and the banks can count on more interest. A $22,000 loan financed over six years, for instance, will bring a bank $2,316 more in interest income than a $22,000 loan financed for three years.

Downside to debt

But the strategy could bite back – for consumers and dealers. Upside-down equity could mean some consumers will roll over old debt into a new loan for a new car and thereby end up deeper in debt. Also, for dealers, it’s harder to sell a new car years later because the dealer first has to get the customer out of a vehicle that hasn’t been paid off.

Tom Gill, president of Tom Gill Chevrolet in Florence, said dealers generally have no choice about loan lengths.

“You have to find out what the consumer needs,” he said. “It boils down to what is the consumer trying to do.

“If a buyer is somebody who buys a car and drives it until the wheels drop off, then 72 or 84 months doesn’t hurt anybody other than the consumer who is carrying more interest.”

Richard Joseph, director of the Joseph Auto Group, argues that zero-interest loans from the manufacturer can counter this problem.

“The benefit to the customer is that 100 percent of the payment is going to the vehicle and not to interest,” he said.

But Robert Riggsbee, president of Inside Media, a media research, planning and buying agency based in Newtown, cautions that longer loans take would-be customers out of the new-car sales cycle for a longer period of time.

Manufacturers and dealers will eventually pay the price, he says. Dealers who encourage long-term loans are propping up short-term profitability and sales.

“The effect is four to seven years down the road,” Riggsbee said. “A dealer can’t survive without selling new cars.”

Off the market

Uninformed buyers are most vulnerable, said David Lo, the Troy, Mich.-based senior manager of automotive finance research for J.D. Power and Associates.

The prospect of a seven-year loan has also led some would-be buyers to lease cars, Lo said.

“Some dealers are very upfront about these issues,” Lo said. “Others just want the sale and don’t make the upside-down nature of loans so apparent.

“Dealers are in business to sell the car – to move the metal. And clearly long-term loans will keep buyers off the market for a much longer period of time.”