How Long Should You Finance Your Next Car?

How Long Should a Car Loan BeThere is no hard and fast answer to how long you car loan should be. There are several factors to consider, the main one being what you can afford without destroying your budget. Here are a few key points that may help you decide the ideal car loan length for your situation.

Payment vs. Total Price

When you look at a car, the first thing a salesperson will ask is ”how much of a payment can you afford?” That question is meant to get you to focus on monthly payments instead of the total purchase price. It also helps a salesperson steer you toward a longer loan term for a more expensive vehicle. The thinking is that as long as the monthly payment meets your needs, you may buy a more expensive vehicle, adding to the dealerships profit margin and the salesperson’s commission. As the buyer you need to focus on the total purchase price in order to avoid paying an excessive amount of interest over the life of a loan.

Higher Interest Rates

The longer your loan term is, the higher your interest rate is going to be. In some cases the rate can double just by adding 12 months to the loan term. Take this example for instance. The national average APR for a 60 month note was 2.69 percent in early 2013. All factors being even, extending that same loan to 72 months brought the APR to 4.9 percent. On a loan of $25,000 for a new vehicle, you would pay an extra $2,158.57 in interest and the monthly payment was only $44 cheaper.

Negative Equity

Everyone knows that your car will lose value immediately after purchased and will continue to do so for at least three years. You will be upside-down on the loan during that period, there is no way to avoid it. If you have a loan that lasts longer than 60 months, the added interest and finance charges will cause you to remain upside-down even longer. Depending on how quickly the vehicle depreciates, you may have negative equity in it for as long as five years.

With negative equity comes the harsh reality of not being able to recoup the balance of your loan when you trade the vehicle in. So, if you want another new car before this one is paid off, you will be forced to finance the remaining balance of the original loan as part of your new loan. By doing that, you guarantee that you will have negative equity in the new car for an extended period of time. Additionally, if the balance on the original loan is too high, you may not be able to get approved for another loan until the balance is paid down.

In my opinion, you should never finance a new vehicle for more than 60 months or a used vehicle for more than 48 months. If you opt for a loan of this length, coupled with a reasonable car payment amounting to no more than 10% of your gross monthly income, you will be in a good position to finance your next car.