How to Choose the right Term Length for a Car Loan

There’s no getting around the fact that cars aren’t exactly cheap, especially these days. In fact, barring a roof over your head, a car will likely be the largest expense you’ll have.

In the United States, paying around $30,000 for a brand new new car is not rare. Even the most basic new economy car with a minimal amount of creature comforts will cost in the vicinity of $15,000. Arguably, it makes more economic sense to purchase a late-model used car, but even in this case, it’s getting progressively harder to find a low-mileage example for under $10,000. As a result, this poses a problem. Regardless of whether one is shopping for a new or used car, most will not have enough cash on hand to buy one outright, so the individual must turn to borrowing the money from a lendor.

Places that finance cars include banks, credit unions, automotive credit institutions and even independent dealerships. One thing a car buyer must realize is that there are lots of extra fees added to a car’s asking price, and this applies to both new cars and used cars. Some of these include sales tax, title and license fees, and dealer prep charges.

Sales tax will be the biggest added expense by far. Unfortunately, even if you buy a car from a private party, most states will require you to pay this tax before it can be registered. Thus, once the dust settles, that hypothetical new car with a sticker price of $30,000 will really cost close to $32,000, and that’s assuming you decline the additional extended warranty that the finance manager will try his or her best to sell!

It is also important to remember that a down payment, trade-in vehicle or a combination of both will reduce the amount of any car loan. As an added bonus, a trade-in at the dealership will also reduce the sales tax on the car you’re planning to purchase.

Now that it’s been established that most car buyers will be borrowing at least some of this total amount of money, the next things that need to be determined are the monthly payments and the length of the loan term. A typical car loan term can range from 3-5 years, and some automakers even have terms that can go as long as six or seven years. Before committing yourself to such an obligation, it is prudent to examine just how this will affect your overall budget.

Regardless of how much you borrow or for how long, it will require disclipine and most likely, sacrifices. If you are already just barely getting by from paycheck to paycheck, taking out a car loan, even for a cheap beater with 175,000 miles on an independent lot that advertises with a sign that says, No Credit? Bad Credit? No Problem! is not a good idea.

On the other hand, if you’ve decided that you can swing that monthly car payment without financial hardship, one of the first things you must ask yourself is how long you plan on keeping the vehicle. If you’re the type of person that replaces your ride every 2-3 years, then a short-term loan is a better choice.

Cars in particular depreciate in value rapidly, and when selecting a loan term that exceeds the length of time you plan on keeping the car, the likelihood of finding yourself “upside down”, or owing more on the car than it’s worth greatly increases. Those who prefer to trade frequently should never, under any circumstances, agree to a deal that advertises no payments for the first 6-12 months. As an example, this is because that car will lose value as soon as it’s driven off the lot. By deferring any payments for such a period of time, the car will depreciate that much more and you’ll be upside down that much faster!

Conversely, if you are the type that drives a car until it falls apart, then a long-term loan makes more sense. However, be warned here: The longer the term, the lower the monthly payment will be, but the catch is it also equates to more interest. First of all, the rate will usually be higher to begin with. Moreover, and typically, the longer you stretch out a car loan, the more you will be paying above and beyond the intial price after that aforementioned dust settles.

On occasion, there are exceptions to higher rates for long-term auto loans. Have you ever seen dealerships that advertise zero percent financing for 60 or even 72 months? This looks great on paper, but in order to take advantage of this, your credit has to be perfect. Moreover, in most if not all cases when this “free money” is offered, it is because the car in question is either an unpopular, slow-selling model, or one that is about to be discontinued; remember Saturn?

With that said however, even a decent used car with a minimum price-tag of about $12,000-$15,000 is not uncommon. So if you choose to go with a longer-term loan, be sure to pick a model with a proven track record of reliability and durability, for it would be quite counter-productive to have a lower montly payment on a piece of junk that is in constant need of repair. In this scenario, you could actually end up paying for such a car twice, if not more.

In the end, the best plan of action is to go with the shortest term that your budget will allow. This equates to a lower interest rate, less overall finance charges and best of all, faster ownership.