Thinking of financing a new or new-to-you car? One suggestion for making a car “affordable” is to choose a long-term auto loan that stretches out your repayment period over five, six, or even seven years. But before you make that commitment, consider these pros and cons:
Pros of a Long-Term Auto Loan
The main reason people choose longer-term auto loans is because they bring the payment down to something within the borrower’s monthly budget. But just because you’re paying less each month doesn’t mean you’re paying less overall – quite the opposite in fact. We’ll cover that below.
With a long-term auto loan from your Credit Union, you have the flexibility to pay more toward your principal at any time, or even pay off your entire loan earlier than planned—without penalty. This is helpful if you come into extra, unexpected cash and can afford to put it toward your car loan. You’ll reduce the overall interest you pay and get that pink slip in-hand sooner.
Cons of a Long-Term Auto Loan
Higher Interest Rate
Long-term auto loans—typically those greater than 60 months—come with a higher interest rate, which means you pay more.
You’ll Pay More for the Same Car
The combination of a higher interest rate and more monthly payments means you could end up paying hundreds or even thousands more for the same car than if you shortened the term. Plus, it will take two years longer to pay off the car.
You’ll Owe More Than Your Car is Worth
Loans are designed so you pay more in interest during the first few years than you do toward the principal amount. But car values (especially new cars) depreciate a lot in those first few years—as much as 19% in the first year alone1. This means you’ll owe more than your car is worth for several years. Why is that bad? If you total your car in an accident or it is stolen, you’re still on the hook to pay back your loan. Thankfully, you can mitigate that risk by purchasing Guaranteed Asset Protection (GAP), which will cover the difference between what you owe on the auto loan and what your insurance company is willing to give you for the car loss.
What Should You Do?
Before you even start researching cars to buy, the best thing you can do is get pre-approved for an auto loan. Arming yourself with this information first will allow you to search for a car within your budget and give you a leg up when negotiating on the price of the car you choose.
Determine What You Can Afford
Once you know the loan amount, rate, and term you’re pre-approved for, decide what monthly payment you’re comfortable with and how much money you plan to put down (or if you’re trading in your car, how much that will be toward your new car). Then, plug all these numbers into an auto finance calculator to help you figure out what the purchase price of your car should be. The key here is that even though you’re approved up to a specific amount, you shouldn’t necessarily look for a car that expensive if you can’t afford the monthly payment.
Final tip: always, always negotiate on the price of the car, not the monthly payment. This should be easily done if you follow the steps above and have your pre-approval in-hand when you’re ready to buy.
1What is the Average Car Depreciation Rate- CarsDirect, May 23, 2016.
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