Now that you understand the basics of financing a car, you may be debating what the length of your loan term should be. We’ll go through the details to help you decide, but the quick and easy answer is that you should pick the shortest length that your budget allows.
Car Loan Term Length Options
To start, it’s probably helpful to understand the available loan term lengths. Car loans are organized into 12-month increments and can range from just a single year to as many as eight years, or 96 months.
Keep in mind that, while a longer loan term may seem appealing to reduce your monthly payments, the amount you’ll pay in interest will increase as the loan term increases, and the average ownership length of a vehicle in the United States is approximately 6.5 years.
New Car Loan Terms
In early 2018, the average loan term for new cars was approximately 69 months, and 85 percent of new cars were purchased with financing.
Even though your interest rate can increase as the loan term increases, longer loan terms are safer for new cars because their interest rates are usually lower than used cars and they haven’t depreciated yet. But, it’s important to note that a new car does lose about 35 to 45 percent of its value within the first three years of ownership.
Therefore, you should aim to be under that 69-month average and avoid loan terms ranging from 72 to 96 months. Higher interest rates and longer loan term lengths are directly correlated with the likelihood of your loan turning upside down – this means the overall cost of what you owe on your loan exceeds the value of your car, which would require you to pay the difference between the two if you choose to sell the car before the loan is fully paid off.
Used Car Loan Terms
The average loan term for used cars in early 2018, approximately 64 months, wasn’t far behind that of new cars. But, only 53 percent of used cars were purchased with financing.
Despite the average used car loan length being only five months shorter than the average new car loan length, you should try to secure a much shorter loan term if you’re going to finance a used car. This is because used cars are generally cheaper than new cars, they incur higher interest rates and they’ve already started depreciating. As a result, it’s advantageous for you to stay within a range of 12 to 48 months to avoid your loan turning upside down.
The right loan term length can vary based on the kind of car you’re buying, but best practices will tell you to limit the length as best you can. The longer the length of your loan means more money you're required to pay in interest, which means the more cost you take on in addition to the price tag on the car. Assess your finances and use a car loan calculator to see what the lowest term length you can afford is.
And, in any case, you should maximize your down payment as best you can to limit the amount of money you’re borrowing. A healthy down payment on a new or used car is one of the best ways to put yourself in a better position to combat its inevitable, rapid depreciation.