The Pros and Cons of Short-Term Auto Loans
Car loans come with a few options. Deciding on the term of your loan also known as the length of your loan is an important part of the decision-making process. A 36-month car loan has a few perks. For some people, it is a great way to pay off a car loan relatively fast. Trying to determine if it is the right choice for you and your family can still be difficult. Knowing what is good and what is bad about a short-term car loan will make the decision process a little bit easier.
The Pros of a 36-Month Car Loan
- Lower Interest: Typically, the shorter the car loan, the better the interest rate the lender will offer. Shorter loans tend to have a lower risk of default by the borrower. The lender rewards short-term loan borrowers by reducing the interest rate. Essentially, you will pay less overall for your vehicle versus signing for an extended car loan.
- Pay Off Your Car Loan Fast: A common car loan length is 60 months or 5 years long. Choosing a short-term car loan locks you into a larger payment versus a 60-month car loan, no going back and paying less. The good news is you are on a path to getting out of debt in a reasonable amount of time. The faster you pay off debt, the faster you can move on to the next latest and greatest thing. The best part about a short-term loan is that it is short term.
- You Never Owe More Than the Car Is Worth: This one you hear all the time but most people do not think seriously about the consequences of owing more than a vehicle is worth. If you are living paycheck to paycheck, owing more than the vehicle is worth is a very bad idea. Coming up with a large lump sum may be nearly impossible leaving you without a vehicle.
A total loss accident can leave you paying lots of money towards a vehicle you can no longer drive. Gap insurance can help, but it doesn't always cover everything. Did you finance a warranty or rollover a prior car loan? Gap insurance will not cover extras rolled into a car loan. Vehicles depreciate and fast. Even a five-year car loan can put you behind when compared to your vehicle's value.
A 36-month car loan will most likely keep you from being underwater on your auto loan. If you go into a short-term loan with zero money down, it is possible to owe more than the value of the vehicle, but it should not last very long. You will be paying down the debt at a faster rate than what the vehicle is depreciating. Always keep an eye on the value versus what you owe. Vehicle depreciation is tricky. Check out KBB.com to see the approximate value of your vehicle.
Start Saving for Something Else
An awesome perk of a short-term loan is freeing up your money. Do with it what you like, but most personal finance advisers would recommend to save it. Save it for your next vehicle purchase to reduce or wipe out a future auto loan. Put it in an emergency fund. Save for your kids' college. Save it to your retirement account. No matter what you do with the extra cash, it is money you would not have access to if you had taken out an extended car loan.
Car Insurance Choices
Wrapping up a car loan early leaves you with more options on your car insurance. We're not saying to run out and drop physical damage coverage, but it is nice knowing you have the option.
Example: A major medical expense arises, and you are struggling to make ends meet. Because you paid off your car loan off fast with a short-term car loan, you can remove comprehensive and collision coverage.
It is just an example of an extreme situation. Hopefully, if the vehicle still holds a lot of value, you would take proper precautions and minimize the driving of the vehicle while coverage was lowered. Physical damage could be added back on at the time you could afford it. The point here is that if you still had a loan on the vehicle, you would not be able to drop physical damage coverage because the lender requires it to be on the policy. If the lender gets notified of the lowered coverage, they will most likely take out a third party car insurance policy which is very expensive and forward the bill to you.
The Cons of a 36-Month Car Loan
- It Ties Your Money Up: Committing to a high monthly car payment is a big decision. Most importantly, the money will not be available for emergency expenses. It is very important to figure out your budget before agreeing to the car loan terms. Make sure the likelihood of being tight on funds is very low throughout the entire course of your loan. It makes no sense to agree to speed up the repayment process just to default and have the vehicle repossessed.
Other Car Loan Term Considerations
Explore all of your options. Use a car loan calculator to help you go through all the numbers. First, find out what the interest rate options are per length of the car loan. Then input the length of the car loan with the coordinating interest rate into the car loan calculator. Write down all the loan payment amounts.
- 48-Month Car Loan: Sometimes the lender charges the same interest rate for both the 36-month car loan and the 48-month car loan. Consider taking the lower monthly payment with the longer loan, then pay more than the minimum. The big difference here is if you run into a financial jam, you can very easily start paying the minimum due to free up money for the emergency.
- 60-Month Car Loan: Even if a 60-month car loan comes with a little higher interest rate, it is still possible to pay the loan off early. (Assuming there are no fees in the small print for paying off the loan early.) Again, just pay more than the minimum due. At the end of the loan, the final difference in interest may not be all that much. Plus, you have the freedom to lower your payment to the minimum due anytime you see fit.
- Longer than 60-Month Car Loan: Going longer than 60 months on a car loan is not recommended. It is usually a sign you cannot afford the vehicle. Refer back to the part about owing more than the vehicle is worth. The higher interest rates combined with the length of the loan nearly makes staying ahead of depreciation impossible.
Paying extra on car loans does not work for everyone. For some, the temptation of accessible cash is just too much. Locking yourself into a short-term loan and committing to improving your financial future only works if you can stick with it. Refinancing is a possibility, but it can also be a hassle. Your best bet is to pick the proper loan the first time around.
It is easy to see there are many more pros to a short-term loan than cons. Please keep in mind there is no perfect car loan for everyone. Everyone has a different story and different circumstances. The most common auto loan is now averaging more than 60 months.
Cars are becoming more and more expensive making a short-term loan more and more difficult to afford. Budgeting properly can be a game changer for your entire future. Choosing the right car loan length can help get you to financial freedom.