How Many Months Should You Finance a Car?

Understanding the loan term is an important step when financing a vehicle. The loan term, or duration of the financing agreement, directly influences your monthly payments and the overall cost of the car. This guide clarifies what a car loan term entails and how to select an appropriate length for your specific circumstances.

Car Loan Term Fundamentals

A car loan term represents the period, expressed in months, over which you repay the borrowed amount for a vehicle. For instance, a 60-month loan means you commit to 60 equal monthly payments.

The loan term directly affects your monthly payment. A longer term generally results in a lower monthly payment. Conversely, a shorter loan term leads to higher monthly payments because the total amount borrowed is spread across fewer installments.

For example, a $25,000 loan at a 5% interest rate might have a monthly payment around $460 over 48 months. Stretching that same loan over 72 months could reduce the payment to approximately $330 per month. While lower payments can seem attractive, this adjustment does not account for the total financial impact over the life of the loan.

Financial Implications of Loan Duration

The choice of car loan duration affects the total amount you will ultimately pay. A longer loan term significantly increases the total interest accrued over time. For example, a $25,000 loan at a 5% interest rate over 60 months might incur about $1,800 in total interest, but extending it to 84 months could raise the total interest cost to approximately $2,800. This happens because interest continues to accumulate on the outstanding principal balance for a longer period.

A risk associated with extended loan terms is negative equity, also known as being “upside down” on your loan. Negative equity occurs when the outstanding loan balance exceeds the car’s current market value. New cars typically depreciate rapidly, losing around 20% of their value in the first year and often 30% within the first two years of ownership.

Longer loan terms slow the rate at which you pay down the principal balance, making it more likely that the car’s value will drop below what you owe, especially in the early years. For instance, if you purchase a car for $30,000 and it loses value quickly, but your loan payments primarily cover interest due to a long term, you could owe $25,000 on a car only worth $20,000. This complicates selling or trading in the vehicle, as you would need to cover the difference between the sale price and the remaining loan balance.

Key Considerations for Your Loan Term Choice

When deciding on a car loan term, consider your monthly budget and overall financial affordability. Determine a comfortable monthly payment that fits within your existing expenses without causing financial strain.

The interest rate and Annual Percentage Rate (APR) also play a role. A lower interest rate can make a slightly longer term more manageable, while a higher rate makes shorter terms more financially advantageous by minimizing total interest paid. Your credit score heavily influences the interest rate you qualify for; a higher credit score can lead to lower interest rates.

Consider vehicle depreciation to avoid prolonged negative equity. New cars, on average, can lose approximately 60% of their value within the first five years. If you anticipate keeping the car for a shorter period, aligning your loan term with the car’s depreciation curve can help prevent owing more than the car is worth when you decide to sell or trade it.

Your personal financial goals and expected ownership period also influence your term choice. A shorter loan term allows you to pay off the vehicle sooner, freeing up cash flow for other financial objectives like saving for a home down payment or retirement. If you plan to keep the car for many years, a longer term might be tolerable, but if you frequently upgrade vehicles, a shorter term can prevent being trapped in a negative equity situation.

Navigating Common Loan Terms

Car loan terms are offered in increments of 12 months, with common durations ranging from 24 to 84 months. While some lenders may offer terms as short as 12 months or as long as 96 months, the most frequently encountered terms are 36, 48, 60, 72, and 84 months.

Shorter terms, such as 36 or 48 months, result in the lowest total interest paid. These terms lead to higher monthly payments but accelerate the path to vehicle ownership and building equity. For example, a 48-month loan on a $35,000 vehicle at 9% APR would result in approximately $6,807 in total interest.

Terms like 60 months often represent a balance between manageable monthly payments and reasonable total interest costs. This five-year term can be a common choice for many borrowers seeking a compromise. Longer terms, such as 72 or 84 months, offer the lowest monthly payments, making more expensive vehicles seem affordable. However, these extended terms significantly increase the total interest paid and elevate the risk of being in a negative equity position for a longer duration. For instance, the same $35,000 loan at 9% APR over 72 months could accrue over $10,400 in interest, and over 84 months, it could exceed $12,300.