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Choosing the length of your vehicle financing is a key step when it comes to picking the perfect auto loan. A longer loan term will lower the monthly payment, but you will end up paying more interest over the life of the loan. A shorter loan term means you will pay less interest overall, but your monthly payments will be higher.
How to determine the right term length
When deciding on your car loan, consider the length of the loan term in relation to the price of the car and your financial situation. A longer loan term will lower the monthly payment, but it might not be the best solution if you can afford a higher loan payment or don’t mind a less expensive vehicle.
Bankrate tip: It is important to consider your budget and how much you can afford — both the transaction and the upkeep — before purchasing a car. Get prequalified for an auto loan with your bank or credit union ahead of shopping for a vehicle.
To find the right term length for your car loan, follow these steps:
- Determine your budget. This should be your monthly budget and how much you want to pay for the car itself. Consider whether your financial situation is likely to change and factor that in.
- Prequalify with at least three lenders. Shopping around can help you qualify for a lower interest rate. Working with your local credit union could afford you better payments, especially if you have an existing relationship.
- Compare the total interest. Take your prequalification results and plug them into an auto loan calculator to see how much you will pay per month and how much interest you would be paying overall.
- Make a decision. Consider both the monthly payment and the overall cost when deciding which loan term is best suited for your needs.
Long-term versus short-term auto loans
While a longer loan will offer the ability to buy a more expensive vehicle, it does mean more interest over a longer duration. So even though the monthly payment will be lower, the overall cost will be more expensive.
A shorter auto loan, on the other hand, offers less interest paid, but a higher monthly cost. If your budget isn’t spot on, or there’s a sudden change in your income, you could end up struggling with those payments.
There is no perfect loan length for every driver so consider the benefits and drawbacks of each before signing off on your next car.
Benefits and drawbacks of a long-term auto loan
A long-term loan is a great choice if your budget cannot cover a higher monthly payment. Since your monthly payment will be lower, it might also make it easier to afford a higher-priced vehicle.
But with a longer auto loan, you will pay more interest overall. A longer-term loan also increases the risk of finding yourself upside-down on your loan or owing more than the vehicle is worth. This scenario can make trading in or selling the car more complicated.
Benefits and drawbacks of a short-term auto loan
Where long-term auto loans can mean an excessive amount of interest, a shorter term means less interest paid overall. It also means that your car will be fully yours even faster. Along with this, newer cars depreciate at a fast rate in the first five years, so it’s likely you won’t end up owing more than your car is worth for an extended period.
If your budget is tight, signing off on a short-term loan is a riskier choice. This is especially true if you don’t have a sizable down payment. To avoid this, stay away from expensive cars that may strain your budget.
Reasons to consider a shorter loan term
There are a few reasons to sign off on a shorter loan. You will pay off your loan sooner, meaning you can take full advantage of the car you’ve purchased, and you won’t be left with a large loan to pay off. Consider these top factors when deciding the length of your loan.
Fewer years to pay
A longer loan term could mean making payments for five to seven years. A shorter, two- to four-year term will put you in full possession of your car much sooner, which means you’ll get the money back in your monthly budget and can use it to pay down higher-interest debts or save.
Less likely to be upside-down on your loan
If you need to sell or upgrade your car, you will have more flexibility to make the change. You likely won’t have a higher balance than your car is worth, making it easier to swap out when you’re ready for a different ride.
Better resale value
Similar to having a lower chance of becoming upside-down on your loan, paying off your car sooner means it will be worth more when you’re done paying it off. That means if your situation changes, and you need to upgrade — or you just want something fresh — you’ll be able to get more for it than if you had to wait five or seven years.
The bottom line
It’s important to be mindful of how much car you can truly afford. Outside of the overall cost of the loan, consider how much you can put towards your car each month — including gas and insurance.
A shorter term may not always be an option for the car of your dreams. But if a similar model is less expensive and can keep you from taking out a longer-term loan, it may be worth the compromise. Whether you opt for a longer or shorter term, be sure to compare rates to get the best deal possible.