When trying to fit a new car payment into a budget, it has become common for buyers to get a longer loan term in order to afford the car they want. But is that the best approach to take when buying a car?
2015 saw an increase of auto loans with 73 to 84 month terms. Are more buyers willing to venture beyond the standard 60 month maximum loan term? And if so, do they understand the risks of doing so?
The Risks of a Longer Car Loan Term
In the past, auto loan contracts would typically range from 36 (3 years) to 60 months (5 years). The reason that a 60 month loan term is suggested to buyers is because of how much a car's value depreciates in five years. After five years, a vehicle's residual value is likely less than 30% of what it originally cost. When you venture beyond this period, the chances of paying on a car that has little to no residual value increases substantially, depending on how much you provided as a down payment when you signed the loan contract.
Also, a longer loan term leads to more money in interest charges. The further the loan is extended, the higher perceived risk of defaulting on the loan. This means that lenders will typically apply a higher interest rate to longer loans.
Another thing to keep in mind is that warranties don’t last forever. For instance, a GM Powertrain Warranty is good for 100,000 miles or five years - whichever comes first. In the case of a seven year (84 month) loan term, driving beyond the 100k mark in the first five years will leave you with two years where the car is out of warranty, even though you will still be making payments.
So, when you factor in higher interest rates, depreciation, and expiring warranties, you can see why extending a loan term beyond 60 months may not be the best idea, especially if you are dealing with damaged credit. While it can provide a short-term benefit in terms of a lower monthly payment, in the long run it could end up costing you a great deal more.
Alternatives to a Longer Term
Instead of entering into a longer loan contract in order to have more affordable loan payments, look into a lower priced new car or a comparable used vehicle. Or, if the need for a new vehicle purchase isn't immediate, take time to gather up funds to boost your down payment and/or repair your credit so you can afford to have a shorter - and better - loan term with a lower interest rate.
However, if you cannot afford to wait to get a vehicle and have no other choice but to go with an extended loan term, try to apply additional funds to your monthly payments whenever possible or try to refinance when you have a better credit rating.
At Drivers Lane we are committed to helping you find the auto dealer that has the expertise to get you approved regardless of your credit history. Complete the fast, free and secure online application today.