When a $38,000 Car Costs $44,000

Jonathan Welsh

With high gasoline prices drawing so much attention lately, the often harsher overall cost of auto financing is being ignored by consumers who are stretching loans on new cars to as long as nine years.

Low monthly payments and no-money-down deals have long been used to shore up car sales in a slumping market. But auto buyers who opt for longer loan terms are more likely to wind up owing more on their car loans than their cars are worth. Car dealers and banks say people in this position have negative equity, but the popular expression is that they are "upside down." Last year, about 29% of car buyers who traded in a vehicle to buy a new one owed more on their car loans than their cars were worth, compared with 20% five years earlier.

The problem has become more vexing as consumers increasingly view life's expenses, from mobile-phone and cable-television bills to car payments and mortgages, in terms of monthly payments rather than total cost. Researchers say few car buyers, for example, know the actual full cost of their vehicles or stop to consider how much more expensive it is to take on a longer-term loan.

Extending the average car loan to five years from three years costs the buyer more than $2,000 in interest, yet loan terms continue to grow. Average maturity of a car loan today is about 70 months, up from 62 last year. Driving the average higher are loans that stretch to seven, eight and even nine years. Longer-term loans typically bring with them higher interest rates, adding to the total cost of financing.

But as autos continue to depreciate rapidly and the length of the average car loan flirts with the six-year mark, more motorists are not only paying more for their vehicles, but are often winding up trading them in before they are paid off.

The pattern among consumers to trade in their cars after about three years hasn't changed for decades. But three-year car loans were the norm 30 years ago, when people began looking for a new car as soon as they paid off their current vehicle. Today, many people begin to think about new cars just halfway through the loan term.

The trend reflects the development of consumer habits in a wide range of financial practices from credit- and debit-card use to home buying and investing. People are increasingly likely to buy expensive goods and services even when they can't comfortably afford them, and use long-term loans or credit cards to reduce the size of payments while spreading them over longer periods.

"It's the way people in the middle class live their lives," says Julie Midkiff, a production director in Atlanta who three weeks ago bought a Honda CR-V using a five-year loan. "I hate the idea of having a loan for that long, but that's what it took to fit my monthly budget."

As overall vehicle sales have flattened or slumped in recent years, car makers and dealers have looked for new ways to make their wares attractive to potential buyers. Low monthly payments have been one of the surest ways. But keeping them low has requires ever-more-precarious financial terms that in some ways mirror the recent perils of subprime lending in the housing market.

The percentage of consumers with negative equity on their car loans has risen and fallen over time and was as high as 39% in 1990. But the amount owed at trade-in has risen steadily in recent years as vehicle prices have increased. Buyers who had negative equity when they traded in their cars last year on average owed $3,062 on their loans, compared with $1,726 in 2000 and $617 in 1990.

Cars, meanwhile, are getting more expensive. The average transaction price keeps climbing at a faster rate than inflation as people covet expensive cars and purchase more extra-cost options. In 2006, the average price paid for a vehicle was $29,316, compared with $28,942 a year earlier and $19,773 in 1996, according to CNW Marketing Research in Bandon, Ore. The researcher says a rising number of people are "buying in the 90th percentile," which means they are purchasing cars with optional equipment that boosts the sticker price close to the vehicle's maximum possible price.

The tendency to buy cars "loaded" with added-cost options is driven in part by the quickening pace of automotive technology. Expensive gear like satellite-navigation and video-entertainment systems once available in only the most luxurious cars are now optional on even entry-level models. Escalating technological advances also mean cars are being redesigned with new, sought-after features at shorter intervals than before, making existing models appear to age faster and enticing consumers to seek the latest models.

Part of the trend is attributable to "an escalation of taste," says Paul Taylor, chief economist for the National Automobile Dealers' Association. As designer clothing and household goods have become available through mass-market outlets like Target and Kmart, consumers have come to expect even everyday products to be flashy and luxurious more than they did just a few years ago. Where people used to be satisfied with safe, reliable transportation, they now regard features like leather upholstery, elaborate stereo systems and heated seats as necessities even on economy cars. They also assess extra-cost options based on how much they add to the monthly payment instead of their total cost, so they have a greater tendency to add luxury features like rain-sensing windshield wipers, power-operated cargo hatches and seats that even massage one's backside.

Such features keep coming at shortening intervals. "In the 1980s, cars were refreshed or redesigned every four to seven years, but now it's happening every two to three years," says Jesse Toprak, an analyst with Edmunds.com, an automotive-research and -buying site. Drivers who want the latest model with the snazziest features often wind up looking for a new car even though they have a year or more to go before paying off their current car.

With such buyers, dealers make a pitch based on getting the customer into a new car and taking the old vehicle in trade while keeping the monthly payment the same. The downside is that the deal may require stretching the terms of the new loan to seven or eight years. "It's the worst way to buy a car," Mr. Toprak says.