An auto loan is an affordable and convenient way to buy a car – but how can you decide what loan term to get? Both short and long auto loan terms have their pros and cons.
Choosing the right term is important because it will impact your monthly payment and your interest rate. Read on to find out how to pick the best loan term for you.
What Is an Auto Loan Term?
The auto loan term means the length of your loan, or how long you have to pay the loan back. A typical range of auto loan terms might be 24 to 84 months. This gives you the flexibility to choose the right term to suit your budget.
How Loan Terms Impact Interest Rates
Different auto loan terms come with different annual percentage rates (APR). Here's what you need to know:
- A shorter loan term will usually have a lower APR.
- A longer loan term will usually have a higher APR.
- This is because your lender figures you're less likely to default on your loan over a shorter term, so they're taking on less risk than for a longer loan term.
How Loan Terms Impact Total Cost to Borrow
As well as affecting your APR, your loan term will impact how much total interest you pay over the life of the loan. Here are a few points to keep in mind:
- A shorter loan term means higher monthly payments but you'll pay less total interest.
- A longer loan term means lower monthly payments but you'll pay more total interest.
- To calculate your total cost to borrow, take your monthly payment and multiply it by the number of payments for your chosen term, then subtract the original loan amount.
What to Consider When Choosing Your Auto Loan Term
It's a good idea to work out your monthly budget of income vs. expenses before you choose your auto loan term. You can then use an auto loan calculator to see which term gives a monthly payment you can afford.
Remember: You can always pay more than the minimum amount due in the months when you have extra money. This is a better option than choosing a loan term that always pushes you to the edge of your budget.
Pros and Cons of Shorter Auto Loan Terms
- Pro: You'll pay your loan off faster.
- Pro: You'll get a lower APR and will pay less total interest over the life of the loan.
- Pro: You'll be less likely to go underwater on your loan, where the market value of your car is lower than the balance of your loan.
- Con: Your monthly payment will be higher.
Pros and Cons of Longer Auto Loan Terms
- Pro: Your monthly payment will be lower and therefore more affordable.
- Con: Your APR will be higher and you'll pay more total interest over the life of the loan.
- Con: You may run the risk of going underwater on your loan if your car loses value (depreciates) at a faster rate than you're paying the loan off. This can mean you owe more than the car is worth, which is called negative equity.
Can I Refinance to Change My Auto Loan Term?
Yes, you absolutely can! If you're not happy with your loan term, you can refinance your auto loan and request a longer or shorter term depending on your situation.
An auto loan refinance can be helpful if:
- Your income has increased and you want a shorter term so you can pay your loan off faster and save on interest.
- You're struggling to make your monthly payments and need a longer term to make your auto loan more affordable.
- You're at risk of defaulting on your auto loan and possibly having your car repossessed.
Next Steps: Choosing an Auto Loan
Now that you have an idea of what auto loan term might work best for you, it's time to look at auto loans and choose a lender that will offer you competitive rates. Be sure to read the fine print and make sure you avoid prepayment penalties and other hidden costs, too.
Shop around a few different lenders and compare rates and fees. You might find your local credit union offers the most value, plus friendly service.