by Susan Paige
Stretching a car loan out to 72 or even 84 months can make the monthly payment you’ll face much lower. This is one of the primary reasons people are tempted to opt for loans with these durations. However, those lower payments also entail more interest, which in turn makes the actual cost of the car much higher.
These are chief among the pros and cons of long-term car loans.
Let’s look at some others.
Accepting a longer loan term can actually be a smart move under certain circumstances. Say for example, you’re expecting a significant windfall within a year or two of purchasing the car. You can get the car with the lower monthly payment afforded by the extended duration of the loan — then pay it off in full when the windfall arrives.
You’re also permitted to pay more than the required monthly payment when your budget allows and the lower amount when it doesn’t. The more payments you make in excess of the contract, the sooner the loan will be paid off. Meanwhile, you also have the flexibility of only being responsible for a more affordable amount when a month is tight.
Con: Covering the Lender’s Opportunity Cost
Longer-term car loans cost more because they usually come with a higher interest rate. Further, you’ll be on the hook for this rate with each payment, even if you pay the loan off early (though not the entire projected amount of interest). Granted you’ll pay less overall if you satisfy the loan sooner than the contract requires, but you will still pay those extra points in between.
This is because lenders factor in their “opportunity cost” when they issue longer loans. The reasoning is someone else could’ve used that money while it was tied up in your loan, which could’ve generated more profit. They charge you more to hold on to the money longer to compensate for the missed opportunity.
Pro: You Can Get More Car
Let’s say you can comfortably pay $500 for 60 months on a $32,000 loan for a car. The same money will put you in a $42,000 automobile if you finance it over 84 months.
Those additional $10,000 will get you more comfort, convenience and safety features. In some cases, you can even get a base model of a much nicer car altogether.
Con: You’ll Owe More Than the Car is Worth
Pretty much every vehicle will take a 20 percent depreciation hit over the course of the first year of your ownership. After that, if it holds its worth reasonably well, you can expect the value to diminish somewhere between 10 and 15 percent each year.
Even at 10 percent annually, the car’s price will have faded by 70 percent when you get to month 60. The drop will be 80 percent in six years and 90 percent in seven.
Meanwhile, given you’ll pay the interest on a car loan up front; your outstanding balance is pretty well guaranteed to be more than the market value of the car toward the end of the loan term. If the vehicle has to be written off as a total loss during this period, your insurance will only cover the market value. You’ll have to come up with the rest on your own to pay off the loan.
That is, unless you pay for gap insurance to cover the difference. Which, of course, will increase your monthly payment — and by extension the total price of the car — even more.
These are three leading pros and cons of longer-term car loans. Whether or not it makes sense for you to take one on depends upon your financial situation and your tolerance for risk. However, financial experts advise against going longer than 60 months on a new car loan.