Auto Loans are Getting Longer - What are the Car Insurance Ramifications?

According to a 2006 study commissioned by the Consumer Bankers Association and conducted by BenchMark Consulting International, 89 percent of new car buyers are financing their vehicles for more than four years. More surprisingly, a full 55 percent are taking out loans of longer than five years. Not only does this have an impact on family finances, but it also has a profound effect on car insurance rates.

'The Useful Life of the Vehicle'

Traditionally, car loans have been for a duration that approximated the useful life of the vehicle. For example, you might take out a three-year loan on a used car, and by the end of the third year, you would be just about ready to trade it in. People often stretch the loan for four years, but loans for more than four have been pretty much unheard of until now.

The real problem with a five-year car loan is that the car owner may want to sell or trade in his car before the five year period is up - but due to the fact that cars depreciate rapidly, he is likely to owe more on the car loan than the car itself is worth. This makes it nearly impossible to sell the car since most people are unwilling to hand over a car and receive nothing but a bill from the bank in return. Worse yet, if the car owner cannot make his payments due to loss of job, divorce, or other financial calamity, he will not be able to find a buyer, and thus the car is likely to be repossessed - a damning black mark on his consumer credit file.

Don't Forget About the Car Insurance Premiums

When a car is financed through a bank or other institutional lender, the car buyer is required to maintain full coverage insurance. The reason is that the lender has a financial interest in the car - if it is totaled, the lender can demand to have the loan paid off. Since the average person cannot pay a $15,000 to $30,000 loan balance out of pocket, an insurance policy is needed. From an insurance perspective, the problem with these longer-term loans is that you need to maintain full coverage on a car that may not merit it. If you bought a 2000 Impala in 2002, its value will have eroded almost entirely by late 2006 - but you will still need to make substantial monthly payments to your insurance company, in addition to your car payment. It's a double whammy!

Of course, the reason for taking a longer-term loan is the reduced monthly payment. If, for whatever reason, you decide a longer-term loan is right for you, be sure to review your car insurance policy at least twice a year. As your car begins to depreciate, be sure to reduce your collision and comprehensive coverages to reflect the car's true value. There's no sense in having $15,000 worth of insurance on a car that is only worth a fraction of that. And while you're at it, shop around for the best car insurance rates. There's no reason to pay any more than you have to.