7 Is the New 5
Not that long ago, when you borrowed money to buy a car, the standard term was 48 months. Then it was 60 months. Now a 7 year car loan is fairly common.Some dealerships will even allow you to spread your payments out over a whopping 96 months or longer. While it might be tempting to drag out your payments on a car for as long as possible, there are pros and cons to doing so.
Here are some things that you should think about when you’re buying your next car and the carrot of a 7 year car loan (or even longer) is dangled in front of you.
The Upside of Long Term Loans
The most obvious advantage of spreading out a car loan over a very long term is your monthly payments will be much lower than they would be otherwise. If you want to buy a more expensive vehicle but can’t afford the monthly payments, you could tack an extra year or two onto the loan to bring the monthly payments down.
Okay, that’s the pro of a super long term loan. Here are some of the cons.
- The longer the loan, the higher the interest rate. When you take out a 6, 7, or 8 year car loan, your interest rate will be higher. You’ll end up paying far more for your vehicle than you would on a 4 or 5 year term.
- At the start of a loan you are usually upside down – you owe more than the car is worth. That situation is made even worse if you don’t make a down payment. With long term loans, you’ll owe more than your car is worth for much longer. If you have an accident and your car is totaled, the insurance company will give you what the car is worth, not what you owe. You could easily end up making payments on a car that you can’t even drive.
- The longer your car loan, the longer it takes to build equity in your vehicle because you spend the first few years paying off mostly interest. When you have little or no equity in your car, you can’t sell it in an emergency to free up much needed funds.
- If you get tired of a car after 6 years and want to get something new but you have a 7 year loan, you either have to wait another year or roll the amount you still owe into another vehicle. Rolling the amount owing into a new loan is generally a bad idea because you end up with an even bigger car loan and bigger monthly payments. If you have a 5 year loan, chances are your car will be paid off and you’ll have enjoyed being loan free for a while by the time the itch to buy a new car strikes.
- Resale value is much better for newer cars. The value of a 7 year old vehicle that you’re still making payments on is much lower than a 5 year old car. After 5 years, a typical car has lost about 55% of its value to depreciation. A 7 year old car has lost 68% of its value. A dealer is going to give you more money when you trade in a 5 year old car in good condition than one that is 7 years old. It might even qualify as a certified pre-owned vehicle.
The best all around Loan
Get the idea? While you might be tempted to go for a 7-year car loan (or longer) to keep your monthly payments down, you’ll be much better off buying a cheaper car. The other alternative is to buy a used car. Interest rates are usually a bit higher for used vehicles but that’s offset by the lower purchase price. The strategy that works best for the majority of car buyers is to finance for 4 years, and put 10% or 20% down, either in cash, or trade.
The graphic above shows what happens when you buy a car for $35000 and finance it for eight years at 5% with no down payment. Because of taxes and other fees, your $35000 car actually costs you $38800. Right off the bat your loan is upside down and the car is worth less than you owe on it until well into your sixth year of ownership. Finally, your car is worth more than you owe. On a shorter term loan, your car is worth more than you owe sooner, especially when you make a down payment.
Looking for a Great Rate and Selection?
If you’re shopping around for a car or auto financing and you have less than perfect credit, visit Auto Loan Kelowna. We have an outstanding selection of vehicles, and great rates on auto loans, even if you have bad credit.