When it comes to paying off an auto loan, some people only need one or two years to pay off their vehicle, while others require several.
As long as you remain within your budget and lack a prepayment penalty, it’s impossible to pay off a loan too quickly; however, it is definitely possible to take too long. Even so, some car dealerships offer the opportunity to make payments over a 96-month period or longer, which might seem like a deal at first, but could result in a number of major drawbacks for the borrower.
How a 96-Month Auto Loan Works
Many borrowers would cringe at the thought of making car payments for five years, let alone eight. However, for others, a longer auto loan term could seem attractive or to be a short-term financial lifesaver.
A December 2013 Experian report proved that people are indeed moving toward longer-term auto loans, with the loan term for a new car averaging 65 months.
Many longer-term auto loans are designed for subprime borrowers, which means they might be 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?
Long Versus Short-Term Auto Loans
It’s important to examine both the pros and cons of going with such a long-term financing commitment, like an 8-year auto loan, in comparison to a shorter loan term,
Pros and Cons of a Short-Term Auto Loan
- 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 interest paid in total: 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.
Pros and Cons of a Long-Term Auto Loan
- Lower monthly payments: For the person who wants to break down the total cost of a car into smaller monthly payments, a longer-term loan 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 you were to extend the loan to eight years, you would pay just $316.50 per month.
- More interest paid: Since you will make interest payments for many more months, you will pay higher total interest for the car. Using the same $25,000 car with a 5% APR over five years, you would end up paying approximately $3,306 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.
As you can see from the comparison, 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?
Should You Ever Take on a Long-Term Auto Loan?
According to CNBC’s “Behind the Wheel” by Scott Adams, president of Adams Automotive Group, it’s not as crazy as it seems to opt for a longer-term loan. One reason is because the likelihood of a vehicle actually breaking down before the loan is up has decreased considerably.
“The average car on the road is 10 years old and has 150,000 miles,” Adams explained.
Most drivers aren’t having trouble keeping up with payments, no matter how long their loan terms are, he said. One reason could be that the demographic for longer-term loans is not what some might think.
The people opting for these loans are actually older consumers who simply need another car, Adams noted. These borrowers are most likely living on a budget, but are responsible with money and will make their payments on time.
He also explained that not as many drivers are experiencing negative equity as one would assume. While he did not outright promote the concept of taking a long-term loan, he did note, “It isn’t quite as bad as it looks.”
Of course, making the decision to take on any type of loan requires plenty of thought and consideration. Choosing a reputable lender, finding affordable auto loan rates and locating a quality vehicle that can last a long time all matters.
The only real reason, however, 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 doing so 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.