There was a time when a five-year loan on a car was considered lengthy. But typical auto loans have been getting longer for a while now. In fact, according to data from Edmunds, the average loan length passed 70 months in 2020—for the first time ever. A significant percentage of those loans stretch as long as 84 months, or seven years.
Conventional wisdom says that you usually wouldn't want to spend that long paying for a quickly depreciating asset like a car. But there may some situations in which an 84-month auto loan makes sense. With all types of loans, whether for a house, car, or college education, you have to consider the tradeoff between four key things:
- How long you will be paying off the loan.
- How much each payment will be.
- The total amount you will pay for the pleasure of buying stuff with someone else’s money.
- What will the value of the asset be at end of the loan? A home requires a long-term loan, but is often an appreciating asset, so principal payments put in over a long time are often partially or entirely recovered. Automobiles by definition are depreciating assets, and so there is usually seldom a chance of any recovery of principal. the longer the loan, the more the asset depreciates.
See How Your 84-Month Auto Loan Stacks Up
The right mix of these three factors will vary depending on your circumstances. Generally speaking, you'll be better off paying off a loan as quickly as you reasonably can. But let's look at how different loan terms work out for you.
For this experiment's sake, let’s say you want to take out a $10,000 auto loan, and you are deciding whether the loan should be anywhere from one to seven years (12 to 84 months). Let’s assume that the interest rate you are offered on all of the loans is 5% annually (though in most cases, your interest rate will increase with a longer loan).
First, let’s consider the biggest “wallet shock” of any loan: the monthly payment. While far from the most important consideration of any loan, it is critical that you will be able to afford this payment each month without straining your budget or dipping into savings.
Monthly Payment and Loan Length
If you are looking to minimize your monthly payment, the 84-month plan is a winner. What’s not to love about a monthly payment that is half the size of a 36-month loan? But you probably also notice that there is not a huge difference between the payment you will be making once the number of years increases: what is the big difference, you will wonder, between a 60, 72, and 84-month loan?
|Term (Months)||Monthly Payment|
The reason banks, car dealerships, and other financial institutions are willing to lend you money is because they make money off of you doing so. The longer you stretch out the length of your loan, the longer you will be paying someone else to be able to do so—and the more you will end up paying in total. While an 84-month loan might seem like a great deal if you are looking at the monthly payment, it will cost you interest.
Total Interest and Loan Length
If money is tight month to month, it may be worth considering that longer loan term. But you might reconsider when you see just how much that longer-term will cost you in interest.
|Term (Months)||Total Interest Paid|
Interest as a Percentage of Your Total Loan Cost
If you choose the 84-month auto loan, more than 14% of the amount you pay will be going toward not your car, but straight to the bank.
|Term (Months)||Interest as a % of Total Loan Cost|
When to Take an 84-Month Auto Loan
As you can see, a seven-year loan will cost you quite a bit. When you consider that, all that time, your car is quickly losing value, it's clearly not a great option. If the 84-month monthly payment is the only one you can afford, then it may be worth considering public transit.
That being said, the 84-month loan is an option if public transit won't work for you, and you can put down a large enough deposit that you won't end up underwater on the loan. Otherwise, you'll need to purchase gap insurance to avoid owing your lender money if your car is totaled for more than the insurance company will pay for it.
If you do take out an 84-month auto loan, be sure to take one that has no prepayment penalty. You should start paying it off faster as soon as you are able to.
The Benefits of a Shorter Loan
There are a lot of reasons not to prolong the time that you owe someone else money. If you can comfortably afford a higher monthly payment, it does not make financial sense to drag it out. You will end up paying less in the long run, and you will have the peace of mind that comes with owning your car outright sooner rather than later.
If you have alternative financing available, or you can borrow cash from a relative to buy a vehicle, you should highly consider doing so to save yourself unnecessary interest payments. Make the biggest possible down payment that you can, and try to pay off the remaining balance as quickly as possible.
If you do not need a vehicle—maybe you live in a major metropolitan area with reliable public transportation or you can easily carpool with a neighbor—think long and hard before you pay thousands of extra dollars in interest on top of all the other costs of owning a vehicle.