Short Term vs Long Term Car Loans

April 22, 2015

In a perfect world we would simply purchase our cars with cash and pay in full, but the vast majority of Americans will need to finance their vehicle purchase.  Some will finance their vehicle purchase for the conventional 60 months, while others will choose 72 or even 84 month options.  In fact, the average car loan term is increasing.  According to the folks at Edmunds.com, 62 percent of the auto loans in 2014 were for terms over 60 months.  Nearly 20 percent of these loans were for 73- to 84-month terms.  With car loan terms on the rise, it is important to understand the relative pros and cons of short and long term car loans.

Pro’s and Cons of Short-Term Auto Loans

Advantages of Short-Term Car Loans

  1. The balance is paid off earlier – Imagine how nice it would be not to have a car payment!
  2. You won’t pay as much in interest as a long term loan.
  3. The vehicle will have a higher resale value when it has been paid off.
  4. There is less of a chance of you becoming “upside down”, or owing more than the car is worth.  Nobody likes to think about it, but cars depreciate.  If more of your monthly payment is applied to the principal and not the interest, as is the case with shorter loans, then there is less of a chance of you owing more on the principal than the car is worth.

Disadvantages of Short-Term Car Loans

  1. A large down payment may be required.
  2. If not making a large down payment, be prepared to face large monthly payments.

Pro’s and Con’s – Long-term Auto Loans

Advantages of Long-Term Auto Loans

  1. You may be able to purchase a more expensive car.
  2. You may be able to establish lower monthly payments.

Disadvantages of Long-Term Auto Loans

  1. You will be making car payments for a longer period of time before the car is paid off.
  2. The car will have a lower resale value when it is paid off.
  3. You will pay significantly more interest.  Not only will you be paying interest for a longer period of time, your rate will also be higher.
  4. It is much easier to become “upside down”.  Early in your loan term, most of your payments will cover interest, and not the principal.  That being said, you will have very little equity in the vehicle. It is possible to become upside down, as the car will likely depreciate at a faster rate than you are building equity.

What makes sense for different types of consumers?

;Short term loans are generally better for the consumer, as you will pay less interest and have a lower risk of becoming upside down.  If you can’t afford the monthly payments associated with a 60 month loan term, then it’s possible you’re shopping outside of your price range. Simply extending the loan term will result in you paying much more for the car in the long run due to interest.

When Long-Term Loans Can Make Sense

In the end, it is important to know what you can afford. There are online payment calculators that can help you understand what cars are in your price range.  Once you have defined your purchasing limits, you will be able to get out there and shop with confidence.

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