Many people are making a costly mistake when they buy a new car. They are extending the terms of their car loans, spending thousands of dollars on additional interest over the course of the loan. According to a report from Experian, the average length of a car loan is currently 66 months, or 5.5 years. That is a record high for the country. Loans that had terms of 73 to 84 months made up 25 percent of all new leases signed.
Why This Happens
The allure of the loans with longer terms is that the monthly payment is typically lower than for an auto loan with a shorter term. It tricks consumers into a false sense of saving money because less of their income is coming out of their pocket every month. Salespeople at car dealerships often take advantage of this mindset by getting the customer to focus on the amount that they will pay each month for the loan instead of the overall cost of the vehicle they are buying.
What Consumers Should Know
It is important for consumers to realize that they will pay more in interest if they choose a loan with a longer term. You will be accruing interest and paying it off over the entire length of the loan. Loans with longer terms also often have higher interest rates because the extended length of time that the consumer has to default on the loan makes the loan riskier in the eyes of the lender.
Let’s look at two hypothetical loans for a new car at the current average price of $27,612. One loan will have a term of 55 months and an interest rate of 2.4 percent, the average interest rate last year for a new auto loan with a term between 55 to 60 months. The other loan will have a term of 84 months and an interest rate of 4.8 percent, the average interest rate last year for a new auto loan with a term between 73 to 84 months.
While the total price of the car is the same, you’d pay $1,574.30 in finance charges with the 55-month loan term versus $4,953.12 in charges for financing the same car for the 84-month loan term. The payments for the 84-month loan term would be $142.98 less per month, but you will pay $3,378.82 more in interest. You will also be paying on the car for two-and-a-half years longer. The best rates are generally offered for loan terms between 36 to 60 months, so get prequalified for a loan with affordable payments at these terms and use that as the price limit for your new car purchase.