Beware the Credit Trap when Shopping Auto Loans Online

There has been a lot of talk lately about the mortgage crisis in America. Is there a similar crisis looming in the car finance industry? Many analysts say yes.

The Danger of the Rollover Loan

One major source of problems is when people buy a new car before the old one is paid off. With some auto loans, online lenders may offer to roll over the balance on the old loan. In order to make the loan affordable it is extended longer than a normal loan, often to seven or more years.

Rolling over a loan is already an expensive choice. The remaining balance on the first loan will charge the borrower interest over a longer period and cost more money. More importantly though, since the loan is for more than the car is worth, the borrower is in an "upside-down" situation. In the event of financial setback, the buyer can't sell the car to settle the debt.

This is made even worse when a couple of years later, the borrower decides to buy another new car, getting another rollover loan, falling deeper in debt, and making it harder to break the cycle.

Why Is This Crisis New?

In the past, repayment terms for car loans were 36 to 48 months and most owners kept their cars longer than the life of their loan. One driving force for this was the high rates on car loans, which peaked at 17.8% in the early 1980s and made people want short loans to minimize total interest payments. According to Comerica Bank, a company that tracks car prices in relation to median family income, cars were also less affordable so people had less incentive to buy cars often.

Today, with some rates on auto loans online falling to 5% or below, the cost of debt isn't as high. Buyers opt for long loans to get lower monthly payments or to buy more car than they can afford. The average auto loan term is over 5.3 years now, nearly half of loans are over six years, and the average size of car loans is forty percent higher than a decade ago.

In addition, car prices are lower compared to average income and people are replacing their cars more frequently than in the past.

Who Is To Blame?

The ease of shopping for auto loans online has given rise to a small community of disreputable lenders and brokers of the "take the money and run" variety. This has added to the problem but that doesn't mean that online car loans are dangerous. Many disreputable online and brick-and-mortar lenders are contributing to the crisis.

As with any internet or non-internet dealings, there are many reputable and honest lenders looking for your business. You have to be a smart shopper who takes the time to find an appropriate lender and who makes sure this loan makes good financial sense.