When financing a car, one of the most important decisions you'll make is selecting the term length of your auto loan. It’s important to educate yourself because sometimes more is less, and the term you choose can seriously affect your budget. The term, which typically ranges from 24 to 84 months, dictates how long you'll be paying off your vehicle and can significantly impact the overall cost of your loan. The average new car loan is close to 72 months, a significant commitment. Finding the best auto loan term involves balancing your monthly payment, interest rate, and total cost of the loan. Here's a comprehensive guide to help you choose the best auto loan term for your financial situation.
Understanding Auto Loan Terms
Before you take the plunge, consider the length of time you are committed to making regular loan payments. Also, think about how much you can afford in total, not just the amount every month.
● Short-Term Loans (24 to 36 months): These loans have higher monthly payments but typically offer lower interest rates. You'll pay off your vehicle faster, reducing the total amount of interest paid over the life of the loan. If you can budget it as about 15 percent of your monthly take-home pay, then by all means, do so. For most folks, this is too quick and the payments are high. If you have savings, try to pay down the loan quickly to reduce your interest paid.
● Medium-Term Loans (48 to 60 months): A middle-ground option, medium-term loans offer a balance between manageable monthly payments and reasonable interest rates. This is a common choice for many car buyers. Today, most buyers can’t even pull off this loan term because they want to buy more expensive vehicles and can’t afford the shorter term, higher monthly payment amounts.
● Long-Term Loans (72 to 84 months): While these loans offer the lowest monthly payments, they often come with higher interest rates. The extended loan term means you'll pay more in interest over time, increasing the total cost of the loan. This is where most new car buyers fall, but it becomes worse when they owe more on the vehicle than it’s worth due to depreciation, known as an “upside down” loan.
Factors to Consider When Choosing a Loan Term
To determine the best auto loan term for you, consider the following factors:
● Monthly Budget: Calculate what you can realistically afford to pay each month without straining your finances. A shorter loan term will mean higher monthly payments, but paying more upfront can save you money in the long run.
● Interest Rates: Shorter loan terms usually have lower interest rates. This means you pay less in interest over the life of the loan. Always compare rates for different terms to see how they affect your total cost.
● Total Loan Cost: While lower monthly payments on a longer loan term might seem appealing, the total cost of the loan will be higher due to accumulating interest. It’s crucial to understand how much extra you'll pay in interest for the convenience of lower payments.
● Vehicle Depreciation: Cars lose value over time, and with a long-term loan, you may end up owing more than the car is worth, a situation known as being "upside-down" on your loan. A shorter term can help you maintain positive equity in your vehicle.
● New or Used: Consider whether the loan is for a new or used car. New cars typically have better interest rates, but they also depreciate faster. For used cars, shorter terms are advisable to avoid excessive interest and maintain equity.
Pros and Cons of Short-Term vs. Long-Term Loans
Here’s a simple way to evaluate what works for you and your family when it comes to determining the best loan term. Take a close look at the pros and cons of each, and weigh it against your family’s budget. These points will help point you in the right direction.
Short-Term Loans
Pros:
● Lower overall interest costs
● Faster equity buildup for your vehicle
● You own the car outright sooner rather than later
Cons:
● Higher monthly payments.
● May limit your car options due to budget constraints
● May be taxing on your budget if you don’t plan well
Long-Term Loans
Pros:
● Lower monthly payments
● A pricier vehicle is within your reach at least for the short term
● Greater flexibility in monthly budgeting
Cons:
● Higher overall interest costs
● Slower equity buildup, increasing the risk of being upside-down on the loa.
● Potentially higher insurance and maintenance costs over a longer period
Finding the Best Auto Loan Term for You
Here are some steps to help you choose the best auto loan term:
● Figure Out Your Financial Situation: Look at your income, expenses, and other debts. Use an auto loan calculator to determine how different loan terms affect your monthly payment and total cost.
● Consider the Loan-to-Value Ratio: Aim for a term that helps you maintain positive equity in your vehicle. Avoid loans that stretch too far beyond the vehicle’s depreciation rate.
● Explore Your Options: Compare offers from different lenders, including banks, credit unions, and online lenders. Pay attention to the Annual Percentage Rate (APR), which includes both the interest rate and any additional fees.
● Shorter is Better if You Can Afford it: If you can afford slightly higher payments, opt for a shorter term. The savings on interest can be significant, and you’ll have the satisfaction of owning your vehicle sooner rather than later.
● Plan for the Future: Consider your long-term financial goals and how an auto loan fits into them. A shorter loan term can free up resources for other priorities like saving for a house or investing.
What Not to Do When Determining Your Loan Term
● Overestimating Your Budget: Be realistic about what you can afford monthly. Stretching your budget too thin can lead to financial stress or missed payments.
● Focusing Solely on Monthly Payments: It’s easy to be lured by low monthly payments, but always consider the total cost of the loan. A lower monthly payment could mean you’re paying much more in interest over time.
● Ignoring Depreciation: Remember that cars lose value quickly, especially new vehicles. Choosing a loan term that matches the rate of depreciation can help you avoid owing more than the car is worth.
Choosing the best auto loan term means finding the right balance between monthly affordability and total cost. You might want the most car you can buy for your money, but your budget says you need to be willing to downgrade. You might want to pay off your loan quicker, but the monthly payments seem too high. While longer terms offer lower payments, shorter terms save you money in the long run and help you build equity faster. By carefully considering your financial situation, interest rates, and long-term goals, you can select a loan term that aligns with your needs and keeps your finances in good shape.
