The length of your loan term depends on a number of things, but balancing it with your monthly payment is a smart way to make sure you get a car loan you can successfully complete. As a borrower with less than perfect credit, it's important that you know where that balance is, because there’s risk involved in long-term auto loans.
Why Is There Risk With Long-Term Auto Loans?
Much of the risk involved in taking out a long-term loan simply has to do with time itself. The longer you have an open loan, and the longer you have any vehicle, the more potential there is for issues.
When you stretch a loan, your monthly payment gets smaller. This may seem like a good idea, but the longer it takes you to pay off your loan, the more likely it is to get caught in a negative equity cycle. This happens when you have to trade in your car before it has equity, which leads to more negative equity in your new vehicle. It can be a vicious cycle that's best avoided – especially if you're struggling with credit issues.
Additionally, when you're determining how long your loan term should be, you have to consider the money you may end up spending. You pay more over the course of a long-term loan, specifically in interest charges. In addition, if you're purchasing a used car, the longer you have it, the more potential there is for issues to crop up, such as mechanical breakdown.
These are just some of the risks you have to consider when you're thinking about how long your loan term should be. For more information on the risks of long-term loans and to see an example of how loan terms could impact your loan, click here.
Average Car Loan Terms
As a bad credit borrower, you're going to face higher interest rates, on average, than people with good credit. This, added to growing car prices, means many people seek to combat higher monthly payments by stretching out their loan terms.
In their State of the Automotive Finance Market Report for the fourth quarter of 2019, Experian found that average loan terms in the U.S. have reached an all-time Q4 high. With a credit score in the nonprime, subprime, or deep subprime range – anyone with a credit score of 660 and below – the average loan term was more than six years on new vehicles. Comparably, the average used auto loan term for people in the same credit range was between five and five and a half years.
But is this average of a loan term between 61 and 74 months the right loan term for you? If not, how can you shorten your loan without increasing your monthly payment too much?
As we mentioned, finding a balance between your monthly payment and your loan term can lead to success with your loan. If you want to make sure that you can afford your monthly payment, one way to do this is by opting for a long-term loan.
The longer it takes you to pay your loan, however, the more expensive it becomes, due to interest charges, which accrue daily based on your loan balance. Rather than stretching out your loan term to 72 or even 84 months, you should strive to make the highest payment you can comfortably afford for the shortest time possible.
To find out the maximum payment that comfortably fits into your budget, you need to know your payment to income (PTI) ratio. Your PTI tells a lender how much of your income is being used for an estimated monthly car loan and auto insurance payment. Lenders typically don't approve you for a loan with a PTI higher than 15% to 20% of your gross (pre-tax) income. Even though 20% is the general cap, the lower your PTI, the better.
You can calculate this yourself by adding together your estimated monthly car loan and insurance payments, and dividing the total by your gross monthly income. If you're not sure what to estimate for a car payment, you can instead find out your maximum combined auto loan and insurance cap by calculating 20% of your monthly income, then working toward a payment under this amount.
Shortening Your Loan Term
If you want the shortest loan term possible, but don't want to increase your monthly payment too much, there are a few options you can consider. Truly, though, your best option is to understand what you can afford and stick to your budget.
Consider getting an affordable, reliable vehicle that holds its value. If you want a newer car without the new car price, check into certified pre-owned vehicles, which are typically low mileage and often have just come off-lease.
Another way to ensure you get the shortest loan term you can afford is by making a down payment. Down payments are one of the best things you can do for yourself when getting an auto loan. The larger the down payment, the less you have to borrow; the less you borrow, the less interest you pay over the term of your loan.
Find Your Next Auto Loan
Now that you have the tools at your disposal to figure out how long your loan term should be, Drivers Lane wants to help you find a dealer to work with. We're teamed up with a nationwide network of special finance dealerships that have lenders for people who are struggling with credit issues. It's simple to begin your search for a dealer in your area! Just fill out our easy, fast, and free car loan request form and we'll get to work for you.