Publish Date - October 22, 2021
Author: Greg Thibodeau
What You Need to Know About Auto Loan Terms
Your auto loan terms determine how long you will take to pay off your loan. It’s tempting to increase the term of your loan in order to lower your monthly payments. However this will probably end up costing you more. It’s usually a good idea to consider other ways of making your loan more affordable
Your auto loan terms determine how long you will take to pay off your loan. It’s tempting to increase the term of your loan in order to lower your monthly payments. However this will probably end up costing you more. It’s usually a good idea to consider other ways of making your loan more affordable.
A car is an expensive purchase and most people need to rely on financing to buy one. It’s important to have a good understanding of your financial situation and the factors that affect your payments to determine the right auto loan terms for you.
The Factors Affecting Your Monthly Payments
There are three main components that determine how much money you’ll have to part with each month to make good on your loan.
The Loan Amount
The loan amount is how much money you need to borrow. If you trade in your old vehicle and make a down payment, the loan amount should be significantly lower than the value of the car you are buying.
The Loan Interest
Sometimes referred to as the APR, the interest rate that you pay on a loan is essentially the fee for borrowing money. It is influenced by factors such as your credit score and the current prime rate. The amount of interest you owe is added to the amount of the loan.
The Loan Term
The loan term is the amount of time that you have to pay back the loan. They typically range from 36 to 72 months. Short terms mean higher monthly payments.
The Problem With Longer Auto Loan Terms
The length of your car loan term is very important as it affects the amount of your monthly payments as well as the total amount that you will have to pay throughout the life of the loan. Make sure you have looked at the numbers and that you know what you’re getting into before you take out a loan.
Having a shorter term means higher monthly payments. People often think that a longer term is better because it lowers their monthly payments but that isn’t necessarily the case. Long auto loan terms come with a set of problems and often end up costing more in the long run.
Higher Interest Costs
Longer loans come with more risk for lenders. The amount of risk that any loan poses affects the amount of interest that lenders charge. Longer auto loan terms mean smaller monthly payments but a higher interest rate and more paid in interest overall.
Long auto loan terms do offer lower monthly payments but you actually owe more due to a higher interest rate. A loan for a term of 72 months may be double that of a 60 month term and that could translate into hundreds if not thousands of additional dollars.
Equity is the value of an asset minus any debts or liabilities attached to it. When you purchase a car and have it financed, your equity in the car is what you could sell if for less the amount owing on the loan. Sometimes this can be a negative number in which case you have negative equity.
Having negative equity means that you owe more than the car is worth. Car loans are prone to this because cars depreciate quickly right after purchase. A new car depreciates about 25% in the first year. Used cars may lose value more slowly but they too depreciate upon purchase. If your down payment is small or the interest rate is high you can find yourself having negative equity in your vehicle.
Having equity gives you choices. It means that you have money you could cash out by selling your vehicle. Negative equity limits your choices. Selling your car won’t wipe away all your debt so you will continue to pay for the vehicle even if you don’t own it anymore.
If the car is totaled in most cases your insurance company will only give you what the car is worth. It will make it even more difficult to buy a replacement car since you will be bringing an existing car loan with you.
It makes sense to minimize negative equity as much as possible. The only way to do that is by decreasing the amount you owe on the car by increasing your down payment or lowering the interest you are being charged. Extending your auto loan terms significantly increases interest rates and that means it will take you longer to build equity in your vehicle.
Lower Resale Value
If you plan on selling your vehicle after you’ve paid it off, consider that the older your car is the less it is worth. Extending your auto loan terms means adding on more time until you own your vehicle. That means you won’t recoup as much of your investment when it’s time to sell.
Extending your auto loan terms beyond five years can make your car ineligible for certified pre owned status. Most automakers won’t consider a car that’s more than 5 years old or exceeds 80,000 miles for the CPO program. A CPO car might get you more money when you’re ready to let it go.
If you’re weighing extending your auto loan terms against these issues you might need to take a closer look at what you can comfortably afford. In most cases it is much more cost efficient to buy a cheaper car with a low interest loan. If you’re not willing to compromise on the car type, maybe buying used could be another viable option.
Another way to lower your interest rate is to improve your credit. A good credit score signifies to lenders that you are likely to pay the loan as agreed making you a low risk borrower. If your credit score is low it might be a good idea to delay purchasing a new vehicle until you can fix your credit.
When all else fails and extending your auto loan terms is the only option, try to negotiate for the kind of loan that will give you options. Some lenders will let you make additional payments and save on interest. This way you can pay off your debt early if your financial situation were to improve over the life of the loan.