CFPB sees risks in longer-term auto loans

While ex­tend­ing the length of a loan can make the monthly pay­ments more af­ford­able, it drives the to­tal cost of the loan higher, as well as the po­ten­tial for de­fault.

Credit Union Journal - - Lending - BY JOE ADLER

WASH­ING­TON — THE SHARP IN­CREASE in longer-term auto loans over the last sev­eral years car­ries added risk for car buy­ers, the Con­sumer Fi­nan­cial Pro­tec­tion Bureau said in a re­port last month.

The re­port said 42 per­cent of car loans is­sued in the last year had a re­pay­ment term of six years or more, a huge leap over the 26 per­cent of car loans that had longer terms in 2009. Over the same pe­riod, fiveyear loans de­clined.

Longer-term auto loans “are more ex­pen­sive and can re­sult in con­sumers con­tin­u­ing to owe even af­ter they are no longer driv­ing their car,” CFPB Di­rec­tor Richard Cor­dray ex­plained in a press re­lease is­sued with the re­port. “Con­sumers should know be­fore they owe and shop for the best deal based on costs in­curred over the life of the loan.”

The re­port, which is de­rived from lend­ing trends the bureau tracks us­ing data from the credit bu­reaus, found that con­sumers with six-year car loans pay con­sid­er­ably more over the life of the loan than those with five-year terms, and ex­pe­ri­ence higher rates of de­fault. Loans six years or longer have had de­fault rates ex­ceed­ing eight per­cent in re­cent years, com­pared with de­fault rates closer to four per­cent for shorter-term loans.

As an il­lus­tra­tion, the CFPB said a bor­rower with a five-year loan of $20,000, at five per­cent in­ter­est, would have paid nearly $2,200 in in­ter­est af­ter three years and have a re­main­ing bal­ance of $8,602.98.

But a six-year loan for the same amount and in­ter­est rate would have cost $152 more in in­ter­est in the same span of time, while leav­ing a re­main­ing bal­ance that is nearly a quar­ter higher.

“While longer loan terms may make monthly pay­ments more af­ford­able, it is not clear that con­sumers are bet­ter off tak­ing out longer-term loans or that they will be more likely to suc­cess­fully re­pay the loan,” the re­port said. “Longer-term loans amor­tize more slowly and, as a re­sult, fi­nanc­ing costs will be higher over the life of the loan.”

The CFPB noted that longer-term loans are used more typ­i­cally by bor­row­ers with lower credit scores. On av­er­age, bor­row­ers who take out sixyear loans have credit scores of 674 — 39 points be­low the av­er­age credit score for those who take out five-year loans. Mean­while, the av­er­age loan amount for six-year loans of $25,300 was nearly 26 per­cent higher than that of five-year loans.

“To the ex­tent that con­sumers are buy­ing more ex­pen­sive cars, mak­ing smaller down pay­ments, or oth­er­wise fi­nanc­ing larger loan amounts, the in­creased use of these longer-term loans may be a re­sult,” the re­port said.

Longer-term auto loans “are more ex­pen­sive and can re­sult in con­sumers con­tin­u­ing to owe even af­ter they are no longer driv­ing their car,” CFPB Di­rec­tor Richard Cor­dray said.

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