THE COLOR OF MONEY
Longer loans defy common sense
By Michelle Singletary | May 7, 2006
It appears we’ve hit another consumer milestone, and it’s not one we should be proud of either.
Last year, it was our savings rate. In 2005, for the first time since the Great Depression, the personal savings rate fell into negative territory.
This year, consumers have hit another landmark. The majority of auto loans are now five years or longer.
New vehicle loans over 60 months accounted for nearly 55 percent of loan originations, according to the Consumer Bankers Association’s 2006 Automobile Finance Study. Used vehicle loans over 60 months accounted for 40 percent of originations.
In 2000, five-year-or-longer car loans comprised just 22 percent of all such lending.
Have people lost their financial minds?
If one projects the “life” of a car at 100k miles, then one can calculate the accumulated depreciation. Ahh, but only businesses do that.
In the early 70′s I found Frau and I on that treadmill. Between us, we came up with an idea how to get out of that rat race. We figured the life of a car at 6 years. We’d go to the credit union for a 36 month car loan and plan to keep the car for a minimum of 6 years. We’d save for three years “painlessly” for the next car.
The credit union was the best place for a car loan since they didn’t use the rule of 78 in computing interest payments. The rule of 78 is a little know gem the auto loan people use to have you pay all the interest up front and the principal later. So if you pay off a loan early, you don’t save any interest. Credit Unions don’t use this fraud. You make your payment and your interest expense goes down. Have a windfall or a few extra bucks? You can pay it down faster and save interest expense at the credit union.
So we’d repay the car loan in 3 years and then continue making the same payment to the credit union for the next three. Our credit union encouraged this by keeping those payments separate from our checking, saving, or other loans.
Then, at the end of six years, we had a substantial downpayment for a new car. Don’t forget that for three of those years we were earning a nice interest rate. We even took CDs for the anniversary date and made a few bucks more. As we got better at it, we “settled” for cheaper cars (i.e., we didn’t get sucked into fancy accessories or “dealer incentives” or expensive options). As we got to the end of that road where we needed to borrow to buy a car, the saved downpayment often equaled the price of the car.
When we finally got out of that necessity to borrow to buy a car, in retrospect, we probably could have adopted a strategy that lowered our overall interest cost. That is take a holistic look at debt and rates and repayment terms. Saving in the car account may not have been the “best” use of credit when one, from time to time, might have had a credit card balance over a month.
But I would assert it was good “education”. It also would allow us to develop the concept of “financial silos”.
Like the early envelope system Frau used, it compartmented our thinking. Closed the water tight doors between compartments in our “financial” ship.
When the entertainment “envelope” was empty, we stayed home. We never raided the new car “envelope” for movie tickets. Not that I wouldn’t have, but she woudln’t let me. ;-)
Financial management was never taught in school, and it’s tough to learn.