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Purchasing a vehicle takes much more than choosing whether to get an SUV or sedan in black or red.
If you’re purchasing the vehicle with a loan, you’ll also have to figure out what repayment terms make the most sense for your budget and financial goals. Car prices are still steep compared to before the COVID-19 pandemic. The average cost of a new car in December 2022 was more than $49,500 — 5 percent higher than the same month one year earlier and more than 20 percent higher than in December 2020, according to Kelley Blue Book.
The longer your loan term — typically ranging from 24 to 84 months, or two to seven years — the cheaper your monthly payments will be. But remember, a lower monthly payment has drawbacks, including potentially costing you more over the long term. For most drivers, a long-term car loan is not a good idea.
Reasons to avoid a long-term car loan
Longer-term car loans are attractive because the monthly payments will be smaller than those with a shorter-term car loan. Though they allow you to buy a more expensive car while still making the payment affordable, long-term car loans can place you in a worse spot financially if you’re not careful.
More likely to become upside down on loan
A longer loan term means you are more likely to be upside down on the loan at some point in the future. Being upside on an auto loan means you owe more than the car is worth. This is because a larger portion of the monthly payments early in the loan will go toward paying interest rather than the principal owed.
Being upside down can be dangerous for several reasons. If you were to have a car accident where the car is considered a total loss, you could end up still having to pay off a loan on a car that you can no longer drive if insurance doesn’t cover it.
In addition, the longer you are upside down on the car loan, the longer you have negative equity. Trading in a car with negative equity means you likely won’t get enough money to pay off the loan — you might even have to roll it into the next car loan you take out.
Depreciation is less of an issue with used cars since a car depreciates the most in its first few years. Even so, long-term car loans on used cars usually aren’t a good idea. A used car likely already has a significant number of miles on it, and a longer-term car loan lets the miles pile up even higher.
For example, assume that you buy a three-year-old car with 36,000 miles on it, which is what the average American would drive in that length of time. If you take out a six-year loan and drive 12,000 miles annually, the average in America, you would add 72,000 miles. This would mean your car would have 108,000 miles on it and would be approaching 10 years old by the time it’s paid off. If you choose to trade it in sooner, you may find it’s not worth much, or worse, that you have no equity at all.
Longer-term lengths typically come with much higher interest rates. This is generally because longer loans are riskier for lenders. With a protracted loan term, there’s a greater chance something might impact your financial circumstances before the loan is fully repaid.
Even in cases where the interest rate on a long-term loan is the same as a shorter term, you will still pay more in interest over the life of the loan because you will be making interest payments for a far longer period.
Although your wallet might feel relief from the decreased monthly payment, the trade-off might not be worth it.
This is an especially important consideration as the Federal Reserve continues to raise benchmark interest rates to address pandemic-related inflation.
When the Fed raises benchmark rates, it drives up interest rates private lenders offer for personal loans and auto loans. The average new loan rate for 2022 was 5.16 percent, according to Experian. However, rates ranged from 3.84 percent for those with the highest credit scores to 12.93 percent for borrowers with the lowest or deep subprime scores.
Stuck with the same vehicle
Before signing off on a car loan that’s as long as 84 months, make sure you’ve found the right car for your needs and consider whether you will want to drive that same vehicle throughout the entire term.
Seven years is a very long time. Your needs and circumstances could shift. But, with a long-term loan, you will be stuck with the same vehicle. And in most cases, rolling over the loan will cost you money.
Alternatives to a long-term car loan
There are other options to get a vehicle without agreeing to the risk that comes along with a long-term car loan.
Lease a vehicle
If you are struggling to get approved for a favorable loan, you may consider leasing a vehicle. Leasing rather than buying a car can provide more affordable monthly payments. Even drivers with fair credit are more likely to receive approval for a lease, and you can still get behind the wheel of a fairly new vehicle.
The downsides of leasing are important to keep in mind. They include restrictions on how many miles you can drive the vehicle during the lease term and fees for excessive wear and tear. And, perhaps most importantly of all, you’ll have to either buy out the lease or return the car at the lease’s end.
Get a co-signer
A co-signer with good credit provides potential lenders with extra reassurance that you will pay off your loan. This makes you more likely to receive approval, even if your own credit is imperfect.
Make a high down payment
If your goal is to lower your monthly costs, making a high down payment is a great option. The larger the amount you put down initially, the lower your monthly payment will be. You are also likely to receive more favorable rates from your lender.
Is a long-term car loan worth the risk?
A long-term car loan is often not a good idea because of the added financial risk. While the lower monthly payment on a long-term car loan may be appealing at first, it is better to save up some additional cash to increase the down payment or to select a less expensive car, so the monthly payment is affordable for a shorter loan.
The bottom line
Before signing onto a long-term auto loan, consider the downsides. In addition to costing you more over the loan’s term, you may also end up becoming upside down on the loan . What’s more, your vehicle needs may be different in five to seven years when you’re still paying off that loan.
Consider the alternatives to long-term loans, such as making a bigger down payment, leasing a vehicle or finding a co-signer whose credit score can help you obtain better loan terms.