The average American driver is taking longer and longer to pay off his or her car. In fact, loan terms are steadily rising, and loans with a length of 72 to 84 months are becoming more and more common. But while taking six or seven years to pay off your car may feel like you’re making room in your budget, it might cost you in ways you don’t realize.
Why Are People Taking Longer Terms
The reason why term lengths are rising is fairly simple: Cars are expensive, and longer terms will mean a smaller monthly payment. In fact, for some of us, the reality is that with our budgets and our financial situation, we have to take the lowest monthly payment we can find.
Too often, however, people just look at the monthly payment and don’t think ahead. You may be paying less monthly, but in the end, it’ll cost you a lot more.
Time Costs Money
Let’s start with the key parts of the loan; the principal is what you borrow, of course. The interest is what you pay, every month, on the principal; consider it the price you’re paying for the loan. And the term is how many payments the principal is divided up into.
You don’t have to be good at math to realize that the fewer interest payments you make, the cheaper your car is ultimately going to be. For example, if you borrow $10,000 at 5% interest and pay it off over 36 months, or three years, you’ll pay a total of $10,800. But bump that up to six years, and you’ll pay a total of $11,600! Nobody’s got enough money that they’re going to turn down an extra $800.
More Money, Less Value
Another factor to consider is that as your car ages, it will, inevitably, be worth less money. That’s not an idle consideration; the value of your trade-in can often substantially reduce the cost of the next car you buy, so you want to have your car paid off and available to trade in as quickly as you can afford.
Needless to say, a long term will make a trade-in harder to achieve; you generally have to own your car before you can sell it, after all. Even a new car is going to be worth far less and break more often if you take seven years to get it completely paid down. It creates a circle where your trade-in is worth less, so you have to borrow more … which in turn forces you to take a longer loan term.
In the worst case scenario, you actually go “upside-down” on your auto loan: That is, your car is worth less than the loan you took out to buy it. In that situation, you’re essentially just throwing your money in the trash.
All that said, if it’s what you can afford and you need a car, you should take the loan that fits your budget. But if you can afford to take a shorter loan, in the long term, it’s going to be better for your wallet.