72 months, is it too long for a car loan? The problems of long-term loans.

The problem with taking a one-size-fits-all approach to a topic like the right car loan term is that it doesn’t take into account, well, you. In other words, your age, your monthly budget, your creditworthiness, etc. are different from your neighbor’s situation. If your credit score is 750, you have a completely different perspective on borrowing money than your neighbor with a credit score of 600.

Our aim is to provide general advice to the average borrower. But even if you’re at the extreme extremes of the credit score bell curve (above 800 or below 500), you can still benefit from the advice presented here.

Confusing the waters, today’s automotive market is affected by a global shortage of microchips and breakdowns in the supply chain. According to analysts at Cox Automotive (the parent company of Autotrader), in the fall of 2021, the average new car was selling for 2% above the manufacturer’s suggested retail price. Prices soared even higher. In other words, buyers paid more than the automakers were asking for the car because demand exceeded supply.

Understanding which borrowing strategy will work best for you in this volatile auto market is harder than ever.

Why buy a car on credit?

Let’s face it, most of us can’t afford cash for a new or even late-model used car. According to Experian EXPGY credit experts,
-0.69%,
less than 16% of new car purchases in the last quarter of 2021 were cash transactions. For the other 84% of us, that means borrowing money from a lender and paying it back month by month until the loan is paid off in full.

Experian reports that the average new car loan amount during the fourth quarter of 2021 was $39,721, with an average monthly payment of $644. This loan amount is up 12% compared to the same period in 2020. The average loan term in the fourth quarter of 2021 was nearly 70 months, with an average interest rate of 3.86%.

Financing is not as critical for most used car buyers. Statistics show that nearly 61% of used car sales in the fourth quarter of 2021 were cash transactions. During this period, the average amount financed on used cars was $27,291 at 8.2% interest. This amount of funding represents an increase of more than $4,600 year over year. The average used car loan term was 67.4 months at $488 per month.

However, very few of us are average. Once we have decided to buy a new car and borrow the money to do so, we need to determine the term (length) of a loan that best suits our budget.

So if you’re wondering what the typical length of a car loan is and what terms to choose, this article should answer most of your questions:

More: Used cars cost more than new ones? Here’s what’s going on and where to find the bargains.

How long can I finance a car?

You may be able to find lenders who will customize auto loan terms, but that’s the exception, not the norm. The most common terms for car loans are 24, 36, 48, 60, 72 and 84 months. Some lenders will even go up to 96 months. However, again, this is an exception and not the norm.

What is the difference between a 24 month loan and an 84 month loan? The simple answer is that the longer the term, the lower the monthly payment. Alright, problem solved, right? What to decide? The math seems to say you should go for the longest term and the lowest payment. However, there is actually more to it.

What are the disadvantages of long-term loans?

When you take out a car loan, regardless of its term, you are not buying the car; the lender does. In other words, the lender pays the seller for the vehicle. Your monthly payments repay the lender. The car isn’t yours until you pay the lender all the money you borrowed. The lender does not lend you the money out of the goodness of his heart. Along with your signed promise to repay the lender, you also agree to pay a fee (the interest rate) for using that money.

When you sign the documents at the dealership, you will be tempted to accept longer loan terms. There’s a reason for this: monthly payments decrease when spread over a longer period. Initially this may seem like more money in your pocket, a good thing.

But the longer the term of the loan, the more you will pay to use the lender’s money. So even though your monthly payments will be lower for a 72 month loan than for a 48 month loan, you will end up paying more for the car. Additionally, many lenders increase the interest rate percentage as the term of the loan increases. You may pay a higher interest rate for a 36 month loan than for a 24 month loan.

For example, using Autotrader monthly car payment calculator, financing a $20,000 car purchase at 4.5% for 36 months will cost $1,418 in interest over the life of the loan. If you finance the same amount at the same interest rate for 72 months, you will spend $2,859 in interest over the life of the loan. That’s an extra $1,441 you’ll pay for this car. And that is if the interest rate itself does not increase in the long term.

Lily: Used EVs: How to Navigate the Tight Market for Used EVs Like the Nissan Leaf and Chevy Volt

There’s more to consider

Let’s say you’re willing to incur the extra cost of a 72 month loan to get lower monthly payments. Paying higher fees for using the money isn’t the only downside to a longer-term loan. Here are two more questions to consider.

First, when using a long-term loan, you will have no equity in the car until very close to the repayment date. This means that you will owe more than the value of the car until the final payments. It will have no benefit as a trade-in if you wish to purchase another vehicle. A lender will carry over the difference between its value and the amount you owe on your next car loan.

Second, most new car warranties expire long before a car is five or six years old. With a longer-term loan, you may well find yourself paying for expensive repairs on a vehicle that you’re still making monthly payments on. None of these questions make financial sense to you or your family.

See: It’s a tight market for the first-time car buyer: How to find the best deal, new or used

What are the disadvantages of short term loans?

So why not opt ​​for a short-term loan and take advantage of a lower rate? For most of us, the main problem is the monthly payment amount for short-term loans. After all, it’s no fun making monthly payments like a luxury car on a non-luxury car, like a Honda Accord or a Toyota Camry, even though you know it’s the smartest financial decision.

For another example, return to our monthly car payment calculator. If you finance $20,000 of a car purchase at 4.5% interest for 36 months, the payment is $595. Financing the same amount at the same interest for 60 months equals a monthly payment of $373.

We all face restrictions with monthly budgets and often have no choice but to spread out the cost of a vehicle. However, avoid 48-month loans if you can.

What is the impact of interest rates on car loan terms?

Beyond the term of a loan, your credit history and other factors can affect your actual interest rate. According to Experian, interest rates for new cars in the fourth quarter of 2021 averaged 3.86% and 8.21% for used cars. Here is an example of the difference between the monthly payment and the total interest cost for two different interest rates.

Let’s take another visit to Autotrader’s Monthly Car Payment Calculator with our $20,000 amount to finance. Financing this amount for 60 months at 3.86% equals a monthly payment of $367 with a total interest cost of $2,024. Financing at 5.0% for 60 months is $377 per month with a total interest cost of $2,645.

Getting the best interest rate you deserve can save you money, no matter how long the loan is.

Is a short-term or long-term loan better?

In the end, our advice is simple: when buying a car and considering a car loan, opt for the shortest term and the best interest rate possible. This option may not be the most appealing idea, as it will increase your monthly payments. Additionally, it may limit the type of car you can afford. But later, you’ll thank yourself for saving thousands in interest and paying off your car years before you thought.

This story originally took place on Autotrader.com.

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