As cars and trucks get more expensive, consumers are taking out longer and longer loans to pay for them. According to credit reporting bureau Experian, the average new auto loan written in the second quarter of 2018 stretched more than 68 months. The average used car loan was nearly 63 months. More than a third of new car loans were for longer than 72 months (six years).
While there are some benefits to having a car loan that’s longer than five years, the problems with having such a long loan drastically outweigh the positives. We’ll show you why in this article.
Topics we’ll cover:
- What Is a Long-Term Auto Loan?
- Benefits of Long-Term Car Financing
- Drawbacks of Long-Term Car Loans
- How to Avoid Long-Term Auto Financing
There’s no specific definition of a long-term car loan, but most experts agree that the negatives start to outweigh the positives when the length of your auto financing is longer than five years. You’ll find lenders, however, who will offer you a 72-month loan (six-years), 84-month loan (seven-years), 96-month loan (eight-years), or even longer loan terms.
Buyers have to be their own advocates if they want to keep their loan terms short. Auto dealers will suggest you stretch them out so they can sell you more expensive cars, and some lenders will offer you long-term financing because they’ll be able to charge a higher auto loan rate and make more money as you repay the debt.
The primary advantage of a long-term loan is a smaller payment. That can allow you to fit your dream car into a monthly budget that could not otherwise afford it.
Here’s an example, using the U.S. News auto loan calculator to figure the payments. You’ve found the perfect SUV, and you’ve negotiated a sales price of $40,000 with no down payment or trade-in. Finance it for five years, and you’ll pay about five percent interest (based on interest rates at the time of writing). Plug those numbers into the car loan calculator, and you’ll see that the monthly payment is $755.
Say $755 is a bit more than you want to spend. If you finance the same SUV for six years, you’ll have to pay a higher interest rate. (We’ll say there’s a quarter point premium, so the rate is 5.25 percent.) However, the monthly payment drops substantially to $649.
What if $755 is a workable monthly payment for you? In that case, a longer-term loan could allow you to buy a more expensive SUV. Working backward with the car payment calculator, you can determine it is possible to buy a $46,500 SUV for about the same monthly payment on a six-year loan as you would have for a $40,000 SUV with five-year financing.
Some car dealers and lenders will tell you the longer-term loan is a great deal. As we’ll see in the next sections, it is a great deal – for them.
On the surface, it might seem like a long-term auto loan is a great deal. Dig a bit deeper, though, and you’ll see the costs and dangers that make choosing a long car loan a horrible idea.
Longer-Term Loans Come With Higher Interest Rates
The interest rate you are charged on a car loan is partially priced on the risk you will not repay the amount you owe. Lenders can demonstrate that the longer a loan goes, the less likely it will be repaid in full. That additional risk is reflected in a higher rate.
For auto loans for consumers with excellent credit scores, the interest rate difference with a longer-term may be small. Buyers with bad credit, however, can see their rates increase dramatically if they want to stretch out their payments. If you have terrible credit, you may not qualify for a long-term loan at all.
Total Interest Costs Are Much Higher
Not only will you pay a higher interest rate on an auto loan with a long term, but you will also pay that higher price for a longer period of time. That means the total cost of the car, including interest, will be much higher if you take out a long-term loan.
We’ll use that SUV from our earlier example to demonstrate. The monthly payment on the five-year loan is $755, while the payment on the six-year loan is $649. However, you’ll be paying those $649 payments for an extra year, compared to the shorter-term loan. To find the total cost of the vehicle, multiply the monthly payment by the number of months in the loan term. For the five-year loan, multiply $755 by 60 months and you’ll find the total cost of the vehicle is $45,300. In other words, the interest cost you’ll add to the SUV’s price is $5,300.
Do the same math on the loan with the six-year loan ($649 times 72 months), and you'll see the total cost of your new SUV becomes $46,728. Despite paying about $100 less per month with the longer loan, you'll pay an extra $1,428 in interest by the time you repay the loan. Stretch your loan to 84 or 96 months, and the additional amount you'll pay in interest will skyrocket.
Easy to Go Underwater
If you opt for an auto loan with an extended term, you had better learn to swim, as you’ll likely be underwater on your loan for a long time. Being underwater on a loan is an industry term for when you owe more money on your vehicle than you can sell it for or an auto insurer will give you if it is stolen or declared a total loss. It’s also called having negative equity or being upside-down on your loan.
If you’re making your monthly payments on time, have no plans to sell, and have purchased adequate gap insurance to bridge the difference between the loan balance and your car's market value, having negative equity isn't a huge problem. Unfortunately, those previous conditions don't apply to many consumers, and they can be in serious financial trouble if they have an accident, or an emergency forces them to have to sell their car.
Let’s look at why having negative equity is such a problem if you have an auto loan with a term that’s longer than five years. New cars (and used cars, to a lesser extent) depreciate rapidly during their first few years on the road, losing a substantial portion of their value within a fairly short time. Some experts say that a new car will lose 10 percent of its value as soon as you drive it off the lot, and 20 percent by the time it has its first birthday. It will likely lose another 10 percent each year for the next few years before its annual loss in value starts to taper off. Of course, some cars depreciate more rapidly than others, and how you use it can accelerate or slow its drop in value.
Car loan balances, on the other hand, decline very slowly over the first few years, with much of each monthly payment going toward interest and not reducing the loan balance. The longer the loan term, the less money applied to the principal balance during the early years of the loan. Your lender can provide you with a chart, called an amortization schedule, that shows the split between interest and principal for every payment during the course of the loan.
Looking at the amortization schedules for our SUV loan example, you would see that with the five-year loan, $588 of the first month’s payment goes toward reducing the loan balance and $167 interest is paid. Switch to the six-year loan, and you’d see a very different picture. $175 goes to interest, and only $474 goes to lowering the balance of the financing.
The difference becomes even more pronounced as loans get longer. Finance the SUV with an eight-year loan at 5.25 percent, and only $336 of the $511 monthly payment goes to pay down the balance of the loan.
When you’re trying to stay above-water on your loan, every dollar that doesn’t go to principal reduces the chance you will be able to keep up with depreciation. Even buyers with four-year loans struggle to keep up with depreciation during the first year of the loan, but they quickly catch up in the second year. Get a loan that's any longer than that, and you won't be in positive equity territory until you're several years into the loan.
See our article for strategies to get out of an underwater car loan for tips on how to get out of a lousy financing deal.
It’s Hard to Escape the Cycle
Once you have a long-term auto loan, it is hard to get a shorter-term loan – especially if you want another new or pre-owned car before you pay off your current loan. Because you will have a substantial balance left until the last couple years of the loan, you’ll have little choice but to roll that remaining balance onto your new auto loan. In order to get affordable payments, it will need to be another long-term loan. You’ll instantly be underwater on your new loan, as well.
Even if you keep the seven-year car loan on for the full 84 months and completely pay off the loan, you’ll likely have trouble affording a shorter-term loan. Because you will always have had a car payment, plus the repair costs of an aging (and likely out-of-warranty) vehicle, you will have little opportunity to save up for a down payment on your next ride.
You’ll Have Repairs Plus Loan Payments
With a four- or five-year auto loan, a new car will have warranty coverage (bumper-to-bumper and/or powertrain) for all, or at least, most of the time you're making payments on it. Get a long-term loan, and you'll likely be well out of warranty coverage before the loan is paid off. If your car is super-reliable, that's not a problem, but many cars will start needing expensive repairs as they reach six or seven years of age. Even if nothing breaks, most vehicles will have some costly routine maintenance requirements during that time period.
Buyers with long-term auto loans will have to pay both their monthly payments and the price of the repairs or maintenance. That’s a huge problem if you have a tight budget and the repairs are unexpected. Charge the maintenance on credit cards with high interest rates, and you could be paying for that maintenance for years.
Fortunately, there are lots of ways to avoid long-term loans. Some require a bit of sacrifice, some a little work, but all will potentially save you significant amounts of money by speeding your auto loan repayment.
Be Careful at the Dealership
Professional car salespeople are skilled at incrementally moving you toward the deal they want you to take. Their most common strategy is to keep you focused on the monthly payment, and not on the price of the vehicle or the terms of the financing. You, on the other hand, want to focus on getting the vehicle price where you want it, with an affordable loan deal. Be cautious if the salesperson says they can get you into a car you didn't think you could afford. They're probably going lead you down the path to an extended loan.
It is critical to read all of the paperwork when you buy a car. Pay close attention to the price, the interest rate you’re being charged, and the length of the loan. Make sure the documents are complete and accurate before you sign. Avoid dealers who will let you take the car home while they finalize the financing. There’s a good chance you’ll be called back to the dealership to sign for a more expensive deal.
Our guide to negotiating the best price on a car walks you through the steps to take to get a great deal.
Buy a Less Expensive Car
It sounds obvious, but the best way to avoid the need for a long-term loan is simply to buy a less expensive car. That might mean a Honda Civic instead of a Honda Accord, or a Toyota Highlander instead of a Lexus RX. You can even save thousands by opting for a lower trim level and giving up a few features in return for significant savings. New car buyers can use our Best Price Program to save money with guaranteed savings at local dealers. With enough savings off MSRP, you can get a shorter loan.
Opting for a used vehicle instead of a new car can save you a ton of money. The original buyer takes the biggest depreciation hit, and you get a car with plenty of life left in it if you buy right. Our guide to used car buying can help you get a great car at an affordable price.
Consider a Certified Pre-Owned Car
A factory-certified used vehicle (CPO car) is a gently used car that’s a few model years old, with relatively low miles, that is sold with a warranty from its original manufacturer at a franchised new car dealer. CPO cars have higher price tags than similar non-certified used cars, but lower prices than brand-new models. Many certified used cars are lease return vehicles.
Factory certified used cars often come with a number of extras, in addition to extended warranty coverage. Some come with roadside assistance, trip interruption coverage, and service loaner vehicles.
Compared to buying a new car, a CPO car will cost you much less to buy. With a lower price tag to pay, you can get a shorter vehicle loan.
Make a Bigger Down Payment
If you have the cash on hand, a great way to avoid a long car loan is to make a substantial down payment. There are several benefits to paying as much as you can up front – the ability to shorten the term of your auto loan is only one of them. It’s not a good idea to completely drain your bank account, but the more you can comfortably put down, the better.
When you make a significant down payment, it lowers your loan-to-value ratio, which is a key metric that lenders look at when determining your interest rate. Getting a better rate can lower your payments or allow you to go even shorter on your auto loan.
Finally, making a bigger down payment increases your chances of having a vehicle that is worth more than the balance of the loan. Having positive equity is safer for your finances, plus it gives you more flexibility if you decide you want a different car before the life of the loan ends.
Look for a Car Deal
A great way to save money and get a shorter auto loan is to take advantage of a manufacturer-supported car deal. Automakers frequently offer generous cash back and below-market interest rate incentives to pick up the sales pace of slower-selling models. A cashback deal has the same effect as making a significant down payment, lowering the amount you have to finance.
Opt for a financing deal, and you’ll get an auto loan with a below-market interest rate that can save you thousands in financing costs over the life of the loan. The best financing deals are zero percent offers, where you don’t have to pay any interest on your car loan. A zero-percent financing deal can also allow you to extend the term of the loan without worrying about skyrocketing interest costs. (It’s one of the few instances in which a longer loan makes sense.)
Car deals are typically offered to buyers with excellent credit, though even if yours isn't perfect, there's no harm in asking for the deal. You can see the best automobile deals available in the marketplace by exploring our new car deals page. Many manufacturers offer financing deals on their certified used cars. You can see those incentives on our used car deals page.
Improve Your Credit Score
Getting your credit in good shape well-before you start car shopping can ensure you qualify for the best rate and car deals out there. The first step is getting your credit score and copies of the credit reports it is drawn from. You can see your credit score as a fringe benefit of many credit cards or go to a site such as CreditKarma.com, which provide your score in exchange for the ability to market financial products to you. Be cautious of sites that require you to sign up for expensive credit monitoring services before you can see your score, as you should be able to find your score for free. You are entitled to a copy of your credit report from each of the three major credit reporting companies – Experian, TransUnion, and Equifax – once per year. The official site to get them is AnnualCreditReport.com.
When you look at your reports, carefully note any errors and contact the lenders in question to get the information corrected. One of the best ways to improve your score is to make your payments on time, every time. Credit bureaus also look at how much debt you owe and the ratio of your debt to the amount of debt you are approved to use.
Buyers with better credit qualify for cheaper auto loans and special car deals from manufacturers. A lower interest rate can help you afford a shorter auto loan.
Shop at Affordable Lenders
Many consumers don’t think about financing until they are at the car dealer. If you want a more affordable auto loan, however, you should start shopping for a loan deal well before you start shopping for a car. Some financial institutions, including credit unions, community banks, and online lenders have a reputation for providing borrowers with low rates.
Having a pre-approval in place before you start heading to dealers gives you a powerful negotiating tool. It forces the dealership to meet or beat the offer you have in hand if they want to earn your business. Because they’re not trying to sell you a more expensive car than you can realistically afford, the loan offers and pre-approvals you receive from outside lenders are likely to be a bit more reasonable than others you’ll be presented with.
Think About Leasing
Leasing a new car can get you into a model with the latest and greatest features for a fraction of the price of buying one. With leasing, you just pay for the amount of depreciation that is expected to occur within the term of the contract, plus interest and fees.
While leasing can get you a lower monthly payment, that expense will continue for as long as you lease the car. You’ll never be without a car payment, and you’ll never actually own a car. However, if you plan on getting a new car every two to three years, it can be a convenient option.
To learn more about the differences, read our article on buying versus leasing.
Refinance Your Loan
Buyers with a long-term loan have another option to save some money. You can refinance an auto loan to get a shorter loan term.
A loan refinance is especially attractive for buyers who had poor credit when they took out the long-term loan, but now have an improving credit score. If your credit picture has improved enough, you might qualify for a lower interest rate.
According to credit reporting bureau TransUnion, buyers who refinance their auto loans lower their interest rate by an average of 2.4 percent. Credit unions lead the way when it comes to refinancing programs, TransUnion reports.
More Shopping Tools From U.S. News & World Report
The expert journalists and researchers of U.S. News Best Cars are by your side when it comes to making one of life’s most expensive purchases. Our new car rankings and reviews are based on the consensus opinion of America’s automotive press, blended with quantifiable information about predicted reliability and safety. Our used car rankings and reviews add ownership cost data to the mix, to ensure you have an affordable car for the long haul.
To help you get a great price on your new vehicle, we track the best deals auto manufacturers are currently offering. Take a look at our new car deals and used car deals pages to see the top purchase incentives, or our lease deals page to find the best lease offers.
The U.S. News Best Price Program connects purchase and lease customers with local dealers offering guaranteed savings. On average, buyers save more than $3,000 by using the service.
In addition to savings off MSRP, getting the best interest rate on your car loan can save you thousands as well. Compare rates from up to four lenders with MyAutoloan to get the best deal.
An essential part of car ownership is getting the right insurance at the best price possible. Our car insurance hub can help you find the auto insurance policy you need and get the insurance discounts you deserve.