The Truth About Car Loan Terms: Shorter is Better
The best loan is always the one that fits your budget and financial goals. But when it comes to car loan terms, our advice is simple: borrow for as short of a term as you can afford. Longer auto loan terms can cost you thousands in car loan interest charges. That’s great for car manufacturers, banks, and auto dealers, but not as good for you.
Caution: Auto Loan Terms are Getting Longer
Over the last 10 years, the average auto loan term has increased from 60 to almost 70 months. Extending the loan term allows the borrower to stretch the payback over more months, making each monthly car payment smaller. So what’s the catch?
Definition: Loan Term
A loan term is the period of time over which you repay your loan, usually stated in months.
Longer car loan terms are better for car makers and lenders
Longer car loan terms are good for car makers. People buy more cars if they can pay less per month to own them. Lenders earn more money because borrowers pay interest for longer.
Dealers can earn 3-5x more if you take a longer auto loan term
For the work the dealer does arranging your loan, the lender pays the dealer a commission. That’s fair.
What doesn’t make sense is that a dealer can earn 5x more commission if you take a 75 month loan compared to a 55 month loan. That means that the dealer has a strong incentive to push you toward a longer loan term from the bank that pays the biggest commission.
An example: Save up to $3,450 with a shorter loan term
But what’s good for you? The table below shows why it’s so tempting to borrow for longer, and the problem it causes.
Loan Amount$32,000$32,000$32,000Loan Term in Months607284Interest Rate6.00%6.50%7.00%Monthly Payment$619$538$479Added Interest$1,611$3,450
The same $32,000 loan can cost you an added $3,450 in interest when your loan term goes from 60 to 84 months. This is for two reasons: your interest rate is likely higher with a longer loan term, and you pay interest over a longer period.
Here’s the trick!
What’s so tempting about that? Your monthly payment can go down by $100 per month. But over the life of the loan, you’re paying much more.
If you arrange financing at the dealership, you’ll hear our least-favorite question: what would you like to pay per month?
How will you know if your dealer is trying to steer you to a longer loan term? You’ll hear our least-favorite question: what would you like to pay per month? That’s the wrong way to start your loan process.
How to get a better car loan, with the right car loan term
When comparing your options, remember that the interest rate on the loan is the price you pay to borrow money. And the best loan is the one that costs the least. We understand that a low monthly payment is important. That’s why you need to shop around to find the right loan for you and your budget.
It’s better ‘Outside’
Outside Financial can help you avoid the games, understand your options, and arrange the financing that's right for you before you go to the dealership. And if you didn’t get your car loan ahead of time, we can help you find a new lender to refinance your auto loan. It’s better Outside.