How Long Should a Car Loan Be?

“Consumers are battling two things,” said Melinda Zabritski, senior director, automotive financial solutions at Experian. They are trying to get a good interest rate and a reasonable monthly payment. But a five-year loan often has a monthly payment that is too high for them, and they end up financing for a longer term even if it costs them more down the line, Zabritski said.

Is there any benefit to having a six- or seven-year car loan aside from a lower monthly payment? No. In fact, there are many reasons why you shouldn’t choose a long car loan. Edmunds recommends a 60-month auto loan if you can manage it. And here are some reasons why.

Car Fatigue

This is something that many people don’t consider before taking out a long loan. We love our cars when they are brand-new, but when the romance fades, we’re eager to trade them in for something else.

The average length of ownership for a new car is about 6.5 years (79 months), according to IHS Markit. Used car ownership averages 5.5 years (66 months). Americans do not tend to drive their cars until the “wheels fall off,” no matter what they say they’re going to do when they buy them.

Let’s take those average lengths of ownership and see what happens with various loan terms.

First, new cars: Imagine you have a 72-month auto loan, and you get the itch to buy a new car seven months after paying off your loan, right about at that common 79-month mark. You are only getting seven months without a car payment. If that’s the case, you would have been better off leasing two cars in succession, at 36 months each. You would have had lower monthly payments and the enjoyment of two new cars.

If you took out an 84-month loan and you grew tired of your car at 79 months, you’d be stuck with five more months of paying for a car you couldn’t wait to unload. If you were really desperate to dump the car, an alternative would be to roll the last five months of the loan into your next car purchase. But that’s almost always a bad idea because it creates a longer loan commitment and higher monthly payments for the next car.

Now let’s look at used cars: Say you buy a 3-year-old used car and pay for it with a 72-month loan, as most people do. And if you’re like most people, you’ll be tired of the car after five and a half years. You will still have six months of payments to go.

Even if you can stand another six months with the car (which is now 9 years old), you will not have a single month without a car payment. Again, you might have been better off leasing two new cars back to back. Lease specials can bring some new cars into a price range that’s comparable to what you’d pay to buy a used car.

Contrast these situations with buyers who’ve chosen five-year loans. At the average ownership mark of 79 months, they have already enjoyed nearly two years without car payments and have the freedom to sell the car whenever they want.

Higher Interest Costs

Higher interest rates are another reason to stick with a 60-month loan. The longer the term, the more interest you will pay on the loan, both in terms of the rate itself and the finance charges over time. Here’s how the numbers look when you compare a 60-month loan to a 72-month loan.

The average loan amount for a new car in the first quarter of 2020 was $33,631, with an average interest rate of 3.6% for a 60-month loan. The finance charges over the life of the loan would be $3,168, giving you a monthly payment of $613, which is a considerable chunk of money. It’s easy to see why someone would opt for a longer loan.

Contrast that with a 72-month auto loan. The interest rate would be higher, which is common for longer loans. According to Edmunds data, the rate is averaging about 6.7% in 2020.

For our new car with a loan amount of $33,631, the monthly payment for the 72-month loan would be about $569. That seems like an improvement over 60 months until you see the finance charges: $7,304 over the life of the loan. That’s more than twice the interest you’d pay with a 60-month loan.

If you purchased a used car with a 72-month loan term, at the average financed price of $22,201, your monthly payment would be $409. It seems like a win from a monthly payment perspective. However, interest rates are much higher for used cars, and a rate of 9.8% is fairly common. You’d be paying $7,251 in finance charges — almost as much as for a new car.

That extra year spent making payments means it would also take longer to build equity in the car. The faster you get to equity the more flexibility you have to sell it or trade it in.

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