When it’s time to purchase your next vehicle, you’ll likely use a vehicle loan to finance it. Most people don’t have the financial resources to buy a vehicle outright, so they turn to their local bank or credit union for financing. You can also find funding through many dealerships and the online vehicle loan marketplace. You’ll want to research several lenders and request prequalification offers from each to ensure you get the best value. One thing to consider when reviewing each offer is how long car loans are typically going to last.
What Is a Vehicle Loan?
You can apply for a vehicle loan when purchasing a new or used vehicle from a dealership or a private seller. Once you’ve been approved, you borrow the money from a lender for a determined length of time at a set annual percentage rate (APR). You will repay the loan and interest via monthly payments to the lender until you pay the loan off in full. Here are some factors that lenders consider when determining the terms of your vehicle loan:
- Your credit history and score
- Your income
- Amount financed
- Age of vehicle
- Type of vehicle
- Down payment, if any
Additionally, the length of your loan is determined by the amount financed plus the age and mileage of the vehicle. Many lenders won’t offer vehicle financing for vehicles over 10 years old or over 125,000 miles on the odometer.
Why Would You Want a Longer Car Loan Term?
A longer car loan term means your monthly payment will be lower, freeing up more of your budget for other expenses. Because your payments are spread out over a longer period, they’re more affordable. Or, depending on the terms of your loan, you can choose to pay more than your minimum payment to pay your loan off sooner if you can afford it. If money is tighter some months than others, you can still make just the minimum payment.
Consider this example of a new car purchase:
- $30,000 at 3% APR for 60 months: $539 monthly payment
- $30,000 at 3% APR for 84 months: $396 monthly payment
While this lower monthly payment is appealing, it’s important to note that you’ll be paying back more in overall interest to the lender, increasing the total cost of your vehicle. With this same example of $30,000 at 3% APR, the total amount of interest paid and total vehicle cost is:
- 60 months: $2,343.64 interest, $32,343.64 total vehicle cost
- 84 months: $3,297.52 interest, $33,297.52 total vehicle cost
By extending your monthly payments from five to seven years, you add almost $1,000 to the total cost of your vehicle. Keep this in mind when considering the length of your car loan.
Why Would You Not Want a Longer Car Loan Term?
A longer car loan term might not be right for you for many reasons, such as:
- Higher interest costs
- Possible higher repair costs
- Owing more than the vehicle’s value
- Negative equity cycle
In the above example of a new car purchase for $30,000, let’s say your new vehicle features a warranty that covers most repairs for 60 months or 100,000 miles, whichever comes first. If you don’t drive many miles annually, you could potentially get all 60 months of warranty coverage for your new vehicle. With the 60-month car loan, your vehicle would be paid in full by the time your warranty expires. With the 84-month car loan, you’d still have two more years to pay off your loan, which would now also include any needed repairs at the same time.
Owing More Than What Your Vehicle Is Worth
It only makes sense that the longer you own your vehicle and the more you drive it, the less value it has. Regardless of the length of your car loan, your vehicle starts depreciating when you drive it home. The longer the loan term, the higher the possibility you’ll owe more than your car is worth at some point. When this happens, it’s called negative equity, and many refer to it as being upside down on a loan.
A new car depreciates between 20% and 30% in the first year. So, that $30,000 example vehicle is now worth between $21,000 and $24,000 at the end of your first year of ownership. If you financed your vehicle and made the minimum monthly payments at the end of the first year, you’d still owe the following:
- 60 months: $24,354.06
- 84 months: $26,089.74
As you can see, even the 60-month car loan is above the estimated vehicle value at the end of year one. Luckily, the vehicle doesn’t continue to depreciate at that rapid rate for the rest of its life, but the further you get from your vehicle’s value, the higher the risk of going upside down on your car loan.
How Long Are Car Loans?
The most common terms for car loans are 24, 36, 48, 60, 72, and 84 months. Experian reports that the average length of a new car loan is just under 72 months. The average car loan repayment term for new cars in quarter two of 2020 by credit score was:
- Super prime (781-850): 66.88 months
- Prime (661-780): 73.04 months
- Non-prime (601-660): 74.28 months
- Subprime (501-600): 73.30 months
- Deep Subprime (300-500): 72.46 months
Super prime borrowers saw the highest increase in term length compared to quarter two of 2019 at 5.9%. The average car loan repayment term for used cars in quarter two of 2020 by credit score was:
- Super prime (781-850): 63.36 months
- Prime (661-780): 67.05 months
- Non-prime (601-660): 66.01 months
- Subprime (501-600): 62.64 months
- Deep Subprime (300-500): 59.19 months
The highest increase compared to quarter two in 2019 for used car loan terms was again the super prime borrowers at 1.5%. Subprime and deep subprime decreased in term length compared to 2019, with deep subprime at -2.1%.
New car loans with terms of 85 to 96 months increased to 4.8% in quarter two of 2020, compared to only 1.3% in quarter two of 2019.
While a lower monthly payment might sound fantastic, it’s imperative to consider the total amount of interest you’ll pay as well as how long you intend to keep the vehicle when selecting a car loan term. One option is to go with the longer term but make weekly or biweekly payments instead of monthly, or round up your payment to pay more principal each month. Doing so provides you with the safety of a lower payment option should an emergency occur that cuts into your budget.
At FIXD, our mission is to make car ownership as simple, easy, and affordable as possible. Our research team utilizes the latest automotive data and insights to create tools and resources that help drivers get peace of mind and save money over the life of their car.