30 Year Car Loan? Why loan amortizations differ

Ah, the allure of lower payments—a siren song to the financially weary. One of the 5 C's of Credit is Capacity; so by stretching out the loan amortization, it lowers their payments, and makes the loan more affordable, right? But before we strap every loan to the back of a turtle and call it a day, let's chat about why we bankers aren't popping champagne over 30-year car loans like we do for mortgages.  There is one over arching idea to keep in mind: You don't want your loan to outlive the collateral, and this can show itself in two ways.

The first one is pretty easy to understand, and we will use our 30 year auto loan as an example.  Even though that 90s era LaBaron convertible was pretty sweet, automobile values are notorious for how quickly they fall, and that doesn’t match well with a long amortization of 30 years.  Let’s work through the math on our loan.  If we were to setup that vehicle with a 30 year amortization, their payment could be as low as $110/mth ($15,000 loan, 8% interest and 30 year amortization).  This makes the loan payment very affordable, and their ability to meet the payment is really high.  After 10 years; however, that vehicle is probably not worth a whole lot, but our loan, well, there would still be $13,158 left on it. Yikes! You had better hope they don’t stop making their payment now because you are facing a big loss if they do.

The second way this shows up is because likely the borrower won’t be done paying for the first car by the time they need to purchase their second car.  This comes down to the useful life of the collateral.  Once a vehicle exceeds 10 years of age, it is nearing the end of its useful life, but if you still have 90% of the loan left to pay, and you can’t sell the car for more than what is owed, you run the risk of the customer needing another loan for their new vehicle while still hoping they continue to make payments on their original loan.  This increases your repayment risk because now they have two car payments, and take a guess which loan they will be late on payments first.

Sure, the idea of a 30-year car loan might sound as outlandish as wearing a tuxedo to a pool party. But it's a lesson in financial reality. When your loan's tied to a depreciating asset, it's like playing Jenga with your money—eventually, something's gonna collapse. Taking the steps to make sure you are protected from the unforeseen risks is the right call.  Sometimes, the bitter taste of higher payments is the only cure for avoiding a financial hangover. Because if you don't, well, your customer might end up swimming in a sea of debt with no life raft in sight (or they will just stop paying, and you'll have to charge off the loan :).