One of the most basic questions you'll need to consider when taking out an auto loan is how long it should be. The length of your loan ultimately sets the stage for how much you end up paying to finance a car. Therefore, car shoppers should carefully assess their situation before determining how long their car loan should be, especially if they are dealing with credit problems.
Auto Loans and Loan Terms
Today, the average car loan has a term greater than five years. According to Experian's State of the Automotive Finance Market report covering the first quarter of 2017, the average new car loan has a 68.53-month term. For used cars, that number checks in at 63.84 months. More alarming than that, Experian found that 34.9 percent of all auto loans for new cars had terms ranging between 73-84 months, while the same is true for 19.5 percent of used car loans.
These types of numbers are cause for some concern. While there are always exceptions, the great majority of personal finance and car buying authorities would advise against consumers ever taking out a car loan with a term of more than five years (60 months).
So, why are more and more consumers opting for longer-term car loans? It's simple really. Car prices continue to go up, while household incomes have remained stagnant. Consumers are combating this by extending their loan terms, which allows them to receive a lower monthly payment.
This monthly-payment mindset isn't exactly financially sound. Consumers are basing most of their decisions on whatever gets them a monthly payment that fits their budget. This is causing them to lose sight of the bigger picture: the total cost of the loan.
By extending a loan term in order to get a lower monthly payment, you end up making the total cost of financing greater. With all else being equal, the longer you finance a car, the more you end up paying in interest charges.
Not to mention, the fact that you end up paying more is only one of the downsides. A longer loan term means it will take more time to pay it off, and this can lead to a host of other problems.
For example, depending on the car you buy and how much of a down payment you make, a longer loan means it takes longer to build equity. You can easily end up upside down sooner and for much longer, which makes it more difficult to sell, trade-in, or refinance your vehicle.
How Long Should My Car Loan Be?
If you are trying to make the smartest financial decision, your loan term should be kept as short as you can afford to. Yes, the monthly payment will be bigger, but this allows you to pay off the loan faster, build equity sooner, and remain flexible. Depending on your situation, you may even be able to enjoy life without a car payment for a time.
The team here at Drivers Lane recommends that car buyers with less than perfect credit do what they can to keep their loan term at 48 months or lower; 60 months at the absolute most.
Here are some tips to help you keep your loan term manageable.
- Before Shopping, Know What You Can Afford - You need to carefully figure out your budget before you even think of heading to a dealership. Salespeople are naturally going to try to upsell you on nicer, more expensive vehicles, but you need to be able to know your budget and have the willpower to stick to it.
- Choose an Affordable Vehicle - Once you have evaluated your budget, you'll have a better idea of your price range. When considering vehicle choices, it helps you to use auto loan calculator tools online. These can give you an idea of the monthly payment you can expect when adjusting the various aspects (such as the term length) of your loan. A tip: if the monthly payment you see on a potential five-year loan is too high for your budget, it means you're not shopping in your price range.
- Use the Payment to Income (PTI) Ratio - The PTI ratio is a calculation lenders use. You can find it by taking the sum of an estimated car and insurance payment and dividing it by your monthly income. This tells you how much of your income is dedicated to car-related expenses. The general rule of thumb is that your PTI ratio shouldn't exceed 10-20 percent of your monthly income, but the lower, the better.
- Have a Down Payment - Experts recommend that you have somewhere between 10 and 20 percent of the car's selling price to put down. A down payment lowers the loan amount. This makes your monthly payments more manageable and reduces the amount of interest charges you end up paying. A down payment can also make shortening a loan term less cost prohibitive.
The Bottom Line
Keeping your loan term as short as you can afford to is the best way to lower the cost of financing, so remember to ditch the monthly-payment mindset and consider the total cost. This is especially true if you are dealing with bad credit.
If your credit is making it tougher for you to get approved for an auto loan. Drivers Lane is here to help. Our service connects car buyers with local special finance dealerships for no charge. See what we can do for you by filling out our car loan request form right now.