“Extended term loans are stupid not only for us, but also for the industry.”

– John Mendel, Honda US Sales Manager

Mr. Mendel explained that competitors are doing stupid things to increase sales and it includes seven-year loan terms. He said automakers are selling more vehicles by offering 84-month loans that lower monthly payments and make it harder to repay the loan faster. He added: “You’re ringing the bell for a new car sale, but that customer is saddled, they are so skinny.”

John Mendel’s interview at the 2015 North American International Auto Show has highlighted a very important aspect of today’s world of auto financing. Several auto finance companies are offering extended loan terms to increase their sales. They are attracting clients by emphasizing lower monthly payments, but deliberately ignoring the high interest part of the deal.

What is the reality of extended loan terms?

Extended loan terms or longer loan terms are attractive because they allow you to buy an expensive car while making smaller payments. But, before opting for a loan program of this type, it is important to understand its reality.

>> The Loan Situation Upside Down

A reverse car loan means you owe more to the lender than the actual value of the car. It is a very dangerous situation because if your car is written off in an accident, you will still have to pay the loan amount. It means that you will have to pay money for a car that you no longer drive.

If you opt for a longer term and smaller monthly payments, you will end up with a reverse car loan. It is because the lenders will direct the monthly payments towards the interest and will not reduce the principal amount.

>> The negative financial situation

The depreciation rate for a car is highest in the early years. And if you opt for extended loan terms, you will make smaller payments. As a result, the outstanding loan balance will not decrease quickly. It will create a negative equity situation. Remember that it is more difficult to trade a negative equity car because it does not have the power to lower the cost of the new asset.

>> The situation of higher interest payments

SCENARIO – 1 – Suppose your loan amount is $ 20,000. If the interest rate is 5% and the term is seven years, the total amount of your interest will be $ 3,744.97.

SCENARIO – 2 – Now, let’s assume your loan amount and interest rate are the same as in Scenario – 1. If the loan term is shortened to four years, you will end up paying $ 2,108.12 in interest. Therefore, it is advisable to opt for a shorter term and save money in the long term.

Now that you have understood the reality of extended loan terms, it is advisable to stay away from them. Remember that it is always the big picture that matters.

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