Next to a house, a new car is probably the most expensive item an average American will purchase in a lifetime. For some, it may be the most expensive item. At the end of the first quarter of 2016, Americans owed $1.005 trillion on car loans, an increase of 10% compared with the first quarter of 2015. Car loans are the third largest source of U.S. consumer debt, behind home mortgages and student loans.

More than 86% of new car buyers borrow money to help pay for the cost of that new car and more than 55% borrow to help finance a used car, according to credit reporting agency Experian. Bank financing accounted for nearly 35% of all car financing in the first quarter of 2016 (new and used, loans and leases), credit unions accounted for 18% and finance companies accounted for 13.4%. Captive (manufacturer or dealer) financing accounted for 26.2% of all financing in the first quarter.

The average loan amount for a new car in the first quarter was $30,032 and the average term of a loan was 68 months. And the lower a buyer’s credit score, the longer the average loan term. Borrowers with higher credit scores take shorter term loans while those with lower credit terms take longer term loans.

The average monthly loan repayment was $503 for a new car, $376 for used car from a franchise and $351 from an independent used car dealer. The average loan rate for a new car was 4.79%, well below the 7.81% rate from a franchised dealer and 60% lower than the 12.22% loan rate from an independent used car dealer.

The loan a consumer chooses is at least as important as the car. And with interest rates near all-time lows, it’s pretty easy to see that a 4.79% new car loan is a better deal than a 12.22% loan from a neighborhood used car lot. That’s where the cost of the car figures in.

The federal Consumer Finance Protection Bureau (CFPB) has created a pencil-and-paper auto loan worksheet that consumers can use to figure out how much a car will really cost. We’re going to use their worksheet to figure the total payments for number of loan repayment plans on an average loan of $30,000 at the average 4.79% rate:

• 36 months = $896 a month for a total finance charge of $2,267
• 48 months = $688 a month for a total finance charge of $3,025
• 60 months = $563 a month for a total finance charge of $3,795
• 72 months = $480 a month for a total finance charge of $4,577
• 84 months = $421 a month for a total finance charge of $5,369
• 96 months = $377 a month for a total finance charge of $6,173

If all things were equal and the monthly payment for a seven-year or eight-year loan were manageable, the longer term loan would be okay, right? Wrong, say the experts at Edmunds; it’s common for longer term loans to carry higher interest rates.

The higher interest rate also means that it takes longer for the buyer to gain some equity value in the car. Because a typical car depreciates by around 22% in the first year of ownership, most buyers will owe more on the car than the car is worth for some period of time. The buyer is said to be “under water” or “upside down.” (Also note: just because the buyer paid $30,000 doesn’t mean that the car was worth $30,000.) As Edmunds points out:

When you have no equity in the car, you can’t sell if it you need the money in an emergency: if your other bills get out of hand or you lose your job, for example. It also gives you fewer options if you get tired of the vehicle. A buyer will only pay you what the car is worth, not what you owe on it. You’re stuck with the balance of the loan.

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Another item to consider before signing up for a long-term car loan is whether the buyers are going to like the car seven or eight years down the road. Also, resale values also drop to less than half the original cost of the car in about five years. Paying off a longer loan could be throwing away money.

The moral of the story, according to many experts, is not to buy more car than you can afford. The same with leasing, as we noted in an earlier story. If the monthly payment on a five-year car is too high, you might be better off setting your sights a little lower rather than stretching out the monthly payments for another year or two or three.

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