Buying a Car: What Term Should Your Loan Be?
Car News
If you’re thinking about buying a car, you’re very likely thinking about financing. You may be attempting to choose the right bank, get the lowest interest rate or find a good monthly payment. Another significant consideration to make is how long you plan on paying off your car (also known as your loan term). We’ve outlined a few factors to help you determine which loan term is right for you.
Before we consider which term is right, it’s very likely best to think about which terms are available. In general, car loans are structured to suggest 12-month increments and last somewhere inbetween two and eight years. That means you’ll find available loans of twenty four months, thirty six months, forty eight months, sixty months, seventy two months and eighty four months. The average fresh car loan is around sixty five months, or more than five-and-a-half years, while the average used car loan is shorter.
When you’re signing the paperwork at the dealer, you’ll be tempted to go for a longer term. There’s a reason for that: By opening up out the payments over a longer period of time, they become lower. Originally, that might seem like it’s more cash in your pocket, and that’s a good thing, right?
The problem with long-term loans is that they come with enlargened interest, which in other words is the extra money you have to pay the bank for providing you the loan. So while a lower monthly payment might seem like it’s benefiting you, it’s usually a worse decision.
As an example, consider a 36-month car loan on a $28,000 vehicle. With a three percent interest rate, the monthly payment is more than $810 — not a petite figure. But the total amount paid over the life of the loan is $29,160, which means the loan only costs the borrower $1,160.
Meantime, consider the same $28,000 vehicle with a 72-month loan where the interest rate has now doubled to six percent. By making the loan longer, the payment drops drastically to just $464 per month. But now the total amount paid is a whopping $33,408, meaning that the $28,000 car costs thousands of dollars extra when financing over the longer term with the higher interest rate.
Short-Term Drawbacks
So why not go for a short-term loan and take advantage of a lower rate? The main problem is the monthly payment. After all, it’s no joy to make luxury-car-like monthly payments on a typical car such as a Honda Accord or Toyota Camry, even if you know in your mind that it’s the smartest financial decision. Instead, most shoppers would rather finance over a longer term, even if it means paying more in the end, to get the payment to an affordable level.
Our Advice: Think Long-Term With a Short-Term Loan
In the end, our advice is ordinary: When you’re buying a car and considering a car loan, opt for the shortest term and the best possible interest rate. In the brief term, this might not be the most appealing idea, considering it will increase your monthly payments, and it may limit the type of car that you can afford. But in the long term, you’ll thank yourself when you’ve saved thousands in interest and paid off your car years before you thought you would.