Long-term car loans have become more and more common in today's automotive finance market. For a bad credit consumer, however, these loans aren't the good deal they appear to be at first glance. Whether or not a long-term loan is a good deal means taking a closer look at balancing the monthly payment with the overall cost.
Long-Term Auto Loans
Car loans can be paid back over a wide range of time. The time frame you have to work with is set at the beginning of your loan, and is typically referred to in months. But, just how long should your auto loan be?
Short-term loans last 36 or 48 months. However, 60- and 72-month loans are more common in this day and age. In fact, loan terms don't stop there. It's not unheard of for people to have 84- or even 96-month loans.
Seven or eight years is a long time to be paying for a vehicle. However, long-term loans do serve the purpose of lowering the monthly payment by breaking the purchase price up into more, smaller payments.
This may sound great on the surface, but if you're dealing with bad credit, this deal is nothing more than a wolf in sheep's clothing. Why? Because interest rates are higher when you have bad credit.
The Cost of Long-Term Car Loans
Higher interest rates means bad credit borrowers pay more for a car loan. The longer a loan takes to pay off, the more you pay in interest charges – this is true of all loans, but the effect is magnified with a higher interest rate.
When you have good credit, the average auto loan interest rate in the U.S. is typically between 4% and 6.5%. With bad credit, though, you're looking at an interest rate between 12% and 20% on average.
Here's an example of how a longer loan term impacts a loan, and how much more it impacts the same loan with bad credit. Assume you're taking out a $14,000 loan with a 6% sales tax. This means your total purchase price is $14,840.
Let's compare these numbers to see how different loan terms impact the overall purchase price, and why loan terms are important:
Good Credit Borrowers – A good credit borrower may be approved for a 60-month car loan at a 5% interest rate. For five years (60 months), this borrower pays $280 a month, and ends up paying $1,963 in interest charges. The same borrower could negotiate a payment under $200 a month by simply changing the loan term. By choosing a 96-month auto loan term, the payment drops to $188 a month. However, the interest charges climb to $3,196, making the loan more expensive overall.
Bad Credit Borrowers – Assume a bad credit borrower is approved for the same 60-month loan at a 12% interest rate. For five years, this borrower pays $330 a month and $4,966 in interest charges. This borrower won't have the option to lower their monthly payment to under $200. In order for this person to get a payment that low, their loan term would end up being 144 months – that's 12 years! A 12-year car loan at this rate won't be available, but if it were, it would end up costing the borrower over $13,000 in interest charges alone.
If we assume that a lender is willing to extend the bad credit borrower's loan term to 96 months, their monthly payment would be $241. However, this results in interest charges of $8,315, which is more than half of the original purchase price. From this perspective, this long-term auto loan wouldn't be worth getting, financially speaking.
Finding Balance in Loan Terms
If you know that your credit isn't in the best shape, make sure you know your credit score and what's on your credit reports before you begin shopping for your next vehicle.
This way, you at least have a ballpark to research the type of interest rates you can expect to see. When you know these things, you can plan your budget and how to balance your monthly loan payment with your loan term.
Generally, you want to get a reliable, affordable car for the shortest loan term you can. However, make sure that you choose a loan term that still allows the monthly payment to fall within your budget.
If your loan term is too short and you can't afford the payment, your vehicle could be repossessed. This makes getting another auto loan in the future much more difficult, especially if you already have bad credit.
Finding Your Next Auto Loan
Now that you know how important loan terms are to the overall cost, you can decide whether or not a long-term loan is worth it to you. When you're ready to take the next step toward a car, start here.
At Drivers Lane, we work with a nationwide network of special finance dealerships that have the lending resources available to help bad credit borrowers. We'll work to match you with one near you if you fill out our fast and free auto loan request form. Get started today!