You’ve finished the fun part of car shopping – researching prices and features, test-driving different rides, and locating your favorite. Unfortunately, that means you are ready to tackle the least pleasant part of the car-buying process – paying for it. And unless you are paying all-cash, that task includes choosing a loan term.
Terms for vehicle loans can vary widely based on the amount of down payment money you supply and the amount of monthly car payment you can afford. Three or four years is a common loan term, but some loans can be stretched out to seven years or more.
While a long-term loan can significantly reduce your monthly payment and appear like a great deal, it is usually not the best choice. Here are four reasons why:
- Higher Interest Costs – The tradeoff for your reduced monthly payment is a significantly higher amount of interest paid over the life of the loan.
Edmunds illustrates this point on their website by comparing a 2013 Honda Accord with five-year and seven-year terms using the available interest rates and price data. Their total to be financed was $30,266.
A five-year loan carried a 2.69% rate and resulted in monthly payments of $540 and $2,115 in finance charges for a total of $32,381 paid. Meanwhile, a seven-year loan carried a 4.9% interest rate and resulted in monthly payments of $426 and $5,548 in finance charges for a total of $35,814 paid.
You would be paying more than double the finance charges just for the ability to pay less each month – and that is comparing seven and five-year loans. Three-year loans provide an even larger contrast.
- Resale Value – Do you plan to keep the car for a long time? Depreciation is rapid for cars, and the resale value drops disproportionately in the first few years after purchase. If you plan to trade the car in relatively early and you have a long-term loan, you could find yourself in a situation where you still owe more on the car than its trade-in value.
If you plan to keep the car for a long time, this is less of a concern. However, an accident in the early years can total your car and throw you into this situation involuntarily.
- Temptation to Overspend – The majority of people stretch out car payments because they cannot afford the monthly payment for a shorter term. However, you should also consider whether buying a less expensive car, or a used car instead of a new car, would be a better choice.
If you aren’t looking at the overall financial picture, a longer-term loan can lead you toward thinking you can afford a more expensive car that you may want but do not necessarily need. This might fulfill the goals of the car salesman — such as paying for his next car with the commissions he earns from your sale — while not being in your best interest.
Clearly, you need to consider not only what monthly payment you can afford, but also project how long you can afford monthly car payments. There will be other expenses in the future to consider.
- Delaying Changes – If you are an average driver, you may get tired of your vehicle before the loan term is up – the average age of a trade-in for 2013 was 6.5 years. You may well love your car for many, many years, but you will be more hesitant to trade and have fewer options if you still owe money on your car.
Before you sign up for that long-term car loan, run some numbers and think about these points. You may decide that a shorter-loan term is in your best interest after all.
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