When you’re getting a new loan to finance a car purchase, deciding its length is often a last-minute decision. But your loan term matters more than you may think when it comes to the cost of borrowing and your financial circumstances. While your first impulse might be to take a longer term in exchange for lower monthly payments, here’s what you need to consider first:
Longer Terms Mean a Higher Borrowing Cost
Usually, the longer your loan term is, the more you’ll pay out in interest and other charges. Edmonds recommends having a loan term of not more than five years for maximum savings. Since longer term loans, such as six or seven years, often have higher interest rates, you may end up paying almost double the amount of interest just for the benefit of a lower payment amount.
You May End Up Underwater
If you have negative equity, you’re said to be “underwater.” This means you owe more on your car than it’s worth. The value of a new car often drops dramatically over the course of its first year, losing an average of 22 percent of its initial retail price.
With a longer loan term, you’re more likely to become underwater on your loan. If that happens, it’ll be impossible for you to sell the vehicle if you’re in a tight financial spot, as you’d still have to clear the loan before the sale. Without equity, your car isn’t a source of emergency cash.
If you’re in a car accident and the car is destroyed, your insurance company will pay only what the car is worth at the time of the event. So if you owe more on the loan than your car is worth, you’re on the hook for the difference.
It’s common to want a new car within five to six years after getting one. Tastes change, people get tired of their current model or life changing events call for a different type of vehicle. But if you have a longer loan term, you may be stuck with your car for months after you’ve decided you want a new one.
With a shorter loan, it’s more likely your car will be paid off when you want a new model. You can sell your used car fast through a dealer or a website such as www.webuycars.com if your loan is taken care of.
Impact on Resale Values
The resale value of your car is another concern when it comes to longer loans. Each year you have your car, it loses value. Dealers tend to favor models that are under five years old, so having a loan that pushes payments to six or seven years will cost you when you go to sell your car after the loan is paid in full.
Ask the financing representative to show you payment tables for all available loan terms if you don’t think you can afford a shorter loan. You may be surprised at how affordable a shorter loan term can be.
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