If you can manage the monthly payments and are aware of the total cost of the loan, financing for more than four years can be acceptable. However, it's generally advisable to keep loan terms shorter if possible, ideally around three to four years, to minimize interest costs and financial risk.
Higher Interest Costs
Over the life of the loan, this can lead to significantly higher total costs compared to short-term loans. The extended interest payments can add up, potentially negating the savings made on monthly payments.
In short, three to five years is usually the best amount of time for a car loan. This range strikes a good mix between manageable payments and low interest rates and risks of depreciation. You should think about your income, interest rates, and how long you plan to keep the car before picking a loan term.
With a long-term auto loan, you face a double whammy—higher interest rates and a longer repayment period—both of which increase your total loan cost. You could end up paying significantly more over the life of the loan compared to a short-term loan.
Long-term finance shifts risk to the providers because they have to bear the fluctuations in the probability of default and other changing conditions in financial markets, such as interest rate risk. Often providers require a premium as part of the compensation for the higher risk this type of financing implies.
The downside to choosing a personal loan with a longer repayment term is paying more in interest charges over the life of the loan. Since lenders charge interest payments monthly, a longer loan term inherently means more interest payments.
Calculator Results
A $30,000 auto loan balance with an average interest rate of 5.0% paid over a 5 year term will have a monthly payment of $566.
Lenders usually charge higher interest rates for long-term auto loans. Because there's more time for a borrower to default on the loan, lenders consider longer-term loans to be a higher risk. To compensate for that risk, they often charge a higher interest rate when you stretch out the loan term.
However, if the burden of monthly EMI that short-term loans get problematic, choosing a long-term, anytime within 7 years would be wise. The monthly pay out would be reduced compared to short-term loans.
If you take out a $35,000 new auto loan for a 72-month term at 4.0% interest, then your monthly payment will be $547.58. Although your monthly payments won't change during the term of your loan, the amount applied to principal versus interest will vary based on the amortization schedule.
On average, a new car buyer with an excellent credit score can secure an average interest rate of 5.25%, but that average jumps to 15.77% for borrowers with poor credit scores. For used car buyers, those averages range from 7.13% to 21.55%, depending on the borrower's credit history.
Financing Costs Are High
If your loan term is longer than 60 months, you end up paying a lot more in interest, especially with rates as high as they are. Secondly, your car is more likely to need very expensive repairs during the life of your loan if it's a longer-term loan, especially if you purchase a used vehicle.
Because of the high interest rates and risk of going upside down, most experts agree that a 72-month loan isn't an ideal choice. Experts recommend that borrowers take out a shorter loan. And for an optimal interest rate, a loan term fewer than 60 months is a better way to go.
It's good practice to make a down payment of at least 20% on a new car (10% for used). A larger down payment can also help you nab a better interest rate. But how much a down payment should be for a car isn't black and white. If you can't afford 10% or 20%, the best down payment is the one you can afford.
A person making $60,000 per year can afford about a $40,000 car based on calculating 15% of their monthly take-home pay and a 20% down payment on the car of $7,900. However, every person's finances are different and you might find that a car payment of approximately $600 per month is not affordable for you.
For example, the interest on a $30,000, 36-month loan at 6% is $2,856. The same loan ($30,000 at 6%) paid back over 72 months would cost $5,797 in interest. Even small changes in your rate can impact how much total interest amount you pay overall.
An increase in your monthly payment will reduce the amount of interest charges you will pay over the repayment period and may even shorten the number of months it will take to pay off the loan.
Drawbacks Of Long Car Loan Lengths
Long loans have more time for interest to accrue, and they tend to have higher interest rates overall. The longer term means your vehicle will likely depreciate before you pay it off, and you might have to pay more than it's worth.
Long-term loans tend to carry less risk for the borrower, but interest rates tend to be at least slightly higher than for short-term loans. Long-term financing is typically used to cover equipment purchases, vehicles, facilities, and other assets with a relatively long useful life.
Most new auto loans have repayment terms of 61 to 72 months. The definition of a “short-term car loan” can vary. Some people consider 36 months (three years) short term, while others consider 60 months (five years) to be a short-term option.