Right now, auto loan interest rates are at an all time low with the average for a new car around 3% and an average term of 69 months. Considering that 86% of new car buyers and 55% of used car buyers borrow money for car purchases according to Experian, it's no wonder auto loans make up the third largest area of consumer debt in the country behind home mortgages and student debt.
If you're in that vast majority of borrowers, an auto loan was probably a good idea considering the return you can get in a retirement or investment account now days. What you may not realize though, is how crazy the subprime auto loans have gotten. We've seen how stringent home loans became after the market crash that started in 2008, but where are auto loans? Since Americans are 1.2 trillion in debt for their cars, you'd think this would be a high priority for policy makers trying to ensure our country's financial stability.
After calling a few dealers, I was shocked to find out what type of loans are out there and usually offered to unsuspecting younger buyers or people with poor credit and a short job history. I called a few dealerships posing as a 21 year old bartender with 18 months on the job, a 550 credit score and a monthly net income of $2,000. I told dealers I was looking for a $10,00 car and was wondering if they would even consider me, and oh boy they would.
One "Buy here, pay here" dealer said it would be no problem at all and I could just pay them $210 every two weeks for three years on a $10,000 car. If you don't have a calculator handy that's $420 a month for 36 months totaling a whooping $15,120 or 29% interest!
I called a larger dealership who was having a "3 day only sale" on used cars. When I gave them the same info, they said an 84 month loan term was an option and that with a 550 credit score I could expect interest rates to start at 10%. Let's be nice and say I get lucky and can finance a $10,000 car for 84 months at that very low 10% figure. Sure the payment would only be $166 per month but it ends up including $3,945 in interest alone! Some car dealers even have a 96 month option now if you're looking to set interest payment world records.
When speaking to a car salesman while researching this article, he said he had just closed a deal on a $3,500 car. The interest rate for the 22 year old buyer with no credit was 35%. He was given an 18 month loan with little down and $1,500 will go straight to interest. He mentioned when you have no credit and no co-signer that you are basically paying to build your credit and some just can't get around it.
To be fair, a financial crisis anywhere near what we saw 10 years ago is not going to happen on defaulting car loans, but considering about a quarter of all auto loans are subprime, some education is warranted at the very least. Some people have no other means of buying a car and in those situations, they have no choice. The real issue is that, these loans are often being sold as an alternative to a shorter term because the monthly payment is more attractive.
Dealerships love to ask, "What monthly payment do you want?" That's never a good way to determine how much you can spend, especially in a world of seemingly never ending auto loan terms. It's usually better to have a slightly higher payment and shorter term. That way you still have equity in the car when it's paid off and you can avoid paying a ridiculous amount of interest. Good luck out there, you're going to need it.
Related: How to Not Get Screwed When Buying a Used Car