The trend toward longer-term auto loans continues; the average loan term for a new auto was 68 months — and 66 months for a used auto loan — in the first quarter of 2016, according to Experian.
Some car dealerships offer even longer terms for an auto finance, like a 96-month auto loan. Many longer-term auto loans are designed for subprime borrowers, which means they might be the best car loans — or even the only option — for those with poor credit who need to finance a vehicle. But does this mean that an eight-year auto loan is a better option than a short-term loan?
An eight-year auto loan might seem like a deal at first, but could result in a number of major drawbacks for the borrower.
Pros and Cons of a 96-Month Auto Loan
If you’re a subprime borrower, eight-year car loan rates or any kind of longer-term auto loan could be ideal for your situation. Learn what a lengthier term like 96-month auto financing could mean for you, by understanding both sides of this loan option.
- Lower monthly payments: Breaking up the total cost of a car into smaller monthly payments with a longer-term loan like 96-month financing could help make the vehicle more affordable in terms of your regular budget. For instance, if you purchase a vehicle for $25,000, at 5% APR, over five years, you will make payments of approximately $471.78 per month. If 96-month auto loan lenders financed your car, you would pay just $316.50 per month.
- More interest: 96-month auto loan rates might be the same as those for a shorter-term loan, but since you’ll make interest payments for many more months, you’ll pay higher total interest for the car with a 96-month used auto loan or new auto loan. Using the same $25,000 car with a 5% APR over five years, you would end up paying approximately $3,307 in total interest. However, paying the same interest rate on an eight-year auto loan would result in spending $5,384.
- Higher negative equity: With a longer-term loan, depreciation increases the likelihood that you will owe more on your car than it is worth each year that passes.
- Warranty issues: Many vehicle warranties only stretch out over a three- to five-year period, which means it’s up to the car buyer to seek a vehicle with a longer warranty, or risk having a vehicle break down out-of-warranty while still making payments.
Pros and Cons of a Short-Term Auto Loan
A short-term auto loan can be helpful if you want to pay off your car more quickly and have the means to do so. Check out the benefits and disadvantages of this kind of loan so you have a better idea of what it entails and you can decide if it’s the best auto loan type for you.
- More competitive rates: Shorter-term loans are most common in the auto loan industry, which means more dealerships and automakers will issue lower interest rate options and car rebates to help reduce the total price of the vehicle and remain competitive with other lenders.
- Less total interest paid: Even though payments are higher, shortening the amount of time you take to pay off a loan means you will pay less interest over the life of the loan.
- Lower negative equity: Negative equity — or an upside-down auto loan — means you owe more on your car loan than your actual car is worth. Depending on how fast your car depreciates and how much interest is tacked onto your loan, you could face negative equity. However, a shorter-term loan increases the likelihood that you won’t have to worry about negative equity.
- Higher monthly payments: Because you are condensing the number of payments made for a car with the same price tag, you’re typically going to opt for higher monthly payments.
Should You Take on a Long-Term Auto Loan?
The comparison shows that there are more reasons to purchase a vehicle under a shorter-term loan. But does this mean you should never purchase a car with an eight-year or longer auto loan term?
The only real reason to take on a long-term auto loan is if you can’t afford higher monthly payments. However, you might want to think about all the cons of such a loan beforehand, as the long-term costs of a longer auto loan might make you reconsider the car price, make and model you choose to finance.