Introduction
Selecting the right loan term when financing an automobile is one of the most crucial decisions that car buyers make. A loan term is the time within which you are expected to repay your loan and it influences both your monthly repayments and the overall cost of the loan. At Automatic Car Credit, we know that borrowers need flexibility, but we also know that there is a lot to consider when it comes to loan options.
This guide will also discuss the different loan term choices, how each affects your money, and strategies for selecting the proper loan term.
What Is a Loan Term?
A loan term is the amount of time within which you commit to repaying an auto loan. Loan terms usually vary between 24 months and 84 months but it is possible to find lenders offering terms as short as 6 months or as long as 10 years. The most frequently used loan terms are 36, 48, 60 and 72 months.
Every term has its own strength and weakness. Knowledge of these will assist you in arriving at a better decision when it comes to financing your car.
Shorter Loan Terms: Pros and Cons
A short term of the loan for instance 24 or 36 months may sound unachievable because it will attract higher monthly installments. However, there are several advantages of taking the loan for a shorter period than the longer period even though the monthly cost will be high.
Pros of Shorter Loan Terms
- Lower Interest Costs:
Reduced loan terms mean that you will pay off the loan in a shorter time and this will lower the total interest you will be charged. Though your interest rate may be a little higher, shorter terms are ideal in that they do not allow much interest to build up.
- Build Equity Faster:
With higher monthly payments, you’ll pay down the principal faster, which means you’ll own more of your car earlier in the loan term. This can be beneficial if you plan to sell or trade in your vehicle before the loan is fully paid off.
- Avoiding Negative Equity:
Negative equity, also known as being “upside-down” on your loan, happens when the value of your car is less than what you owe. Shorter loan terms help you avoid this situation since your balance reduces quickly.
Cons of Shorter Loan Terms
- Higher Monthly Payments:
The primary drawback of shorter loan terms is the higher monthly payment. For some borrowers, the added financial pressure may make it difficult to manage other expenses or save for future goals.
- Less Flexibility:
A higher monthly payment means you’ll have less room in your budget to cover unexpected expenses. If you encounter financial difficulties, a high car payment may add to your stress.
Longer Loan Terms: Pros and Cons
Longer loan terms, such as 60, 72, or even 84 months, have become increasingly popular in recent years due to their lower monthly payments. However, this affordability comes with trade-offs that borrowers should be aware of.
Pros of Longer Loan Terms
- Lower Monthly Payments:
The primary benefit of choosing a longer loan term is the lower monthly payment. This can make it easier to afford a more expensive car without straining your monthly budget.
- Increased Flexibility:
A lower payment provides more room in your budget for other financial obligations, whether that’s building an emergency fund, saving for a down payment on a house, or simply having more disposable income.
Cons of Longer Loan Terms
- Higher Interest Costs:
While your monthly payment is lower, the total cost of the loan is higher with a longer term. This is because interest has more time to accumulate, and even a low interest rate can result in significant additional costs over a longer period.
- Slow Equity Buildup:
With smaller payments, you’ll pay down the principal more slowly, which means it takes longer to build equity in your vehicle. This increases the risk of becoming upside down on your loan, especially with the rapid depreciation that occurs during the first few years of ownership.
- Staying in Debt Longer:
A longer loan term means you’ll be in debt for an extended period. If you choose an 84-month loan, you could be making car payments for seven years—longer than some people keep their vehicles.
Finding the Right Balance
When deciding between a shorter or longer loan term, consider the following factors to determine what works best for your financial situation:
- Monthly Budget
Begin with the evaluation of your monthly budget. Even though lower payment amounts may be more attractive, it is crucial to avoid the loan term that would leave you unable to pay other bills or save for future goals and needs.
- Total Loan Cost
Beware of the total cost of the loan rather than the monthly payments. While a longer term may appear cheaper on a monthly basis, think about the added interest you’ll have to pay over time.
- How Long You Intend to Own the Car
If you are going to own the car until the end of the loan, then longer terms could be more suitable for you. However, if you plan to sell or trade your car in a few years, a shorter loan term will help you establish equity quickly so that you are not in a negative equity position when you decide to change your car.
- Interest Rate
The rates that you will be offered will be a key determinant of the cost of the loan and hence the affordability. However, if you can get a good interest rate, then a long term investment may not be very expensive. On the other hand, if your interest rate is higher, a shorter term will help you save more money in the long-run.
Bottom Line
The appropriate loan term of your auto loan depends on the borrower’s financial circumstances. Shorter loan terms are less expensive in terms of interest and allow you to pay off the loan more quickly while longer loan terms provide lower monthly installments and greater freedom. At Automatic Car Credit, we understand that it is our responsibility to ensure you get the best auto loan. Whether you need a short term loan or a longer term loan at a lower rate, we will assist you in the process and help you drive away in style.