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. Auto loans come in several different terms, and each one can be beneficial to different consumers. Consumers are typically able to choose between 24- to 72-month loans. The major difference between the terms is the amount of interest you will pay, and the dollar amount of your payments.
Shorter loans will come with less interest over the term and have higher payments. Longer-term loans will have lower monthly payments, but more interest over the term. One key element to keep in mind is that the longer you make payments, the more you are paying for the car; this can lead to you paying more for the car than you negotiated or that it is worth.
A 36-month car loan, as a term in the middle of the pack, is attractive to buyers that can afford mid-range monthly payments and mid-range interest rates. This term length can allow you to pay off a car loan faster than longer loans, letting you get the most out of your car and money. Knowing what is good and bad about shorter-term auto loans can help you budget appropriately.
The Pros of a 36-Month Car Loan
Typically, the shorter the car loan, the better the interest rate the lender will offer—this is because 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.
The most common car loan length on a new vehicle is 69 months ( 5.75 years) long—for used vehicles, the average term is 65 months (5.4 years).
Choosing a short-term car loan locks you into a larger payment vs. a 60-month car loan. The benefit is that 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 get back to saving. The best part about a short-term loan is that it is short term.
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.
It helps to pay down the loan debt faster than the vehicle is depreciating—this can help you get more back for the vehicle should you choose to sell it.
Shorter-term loans help you free up your money faster. This can help you to pay off an expensive item and enjoy it before it wears out. You could also save the money for your next vehicle purchase, put it in an emergency fund, your kids' college savings, or place it in 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.
Cons of a 36-Month Loan
Committing to a higher monthly car payment is a big decision. Most importantly, the extra money spent will not be available for emergencies or other expenses. It is very important to ensure the payments fit your budget before agreeing to the car loan terms. Make sure the likelihood of becoming 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.
If you accept higher monthly payments for a shorter term, while decreasing your savings and emergency fund contributions, you might reduce your ability to maintain the vehicle or make costly repairs that occur from time to time.
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.
A 24-month car loan is simply not feasible for most consumers. This is a very short-term loan, and drastically increases the dollar amount of your monthly payments. Interest rates should be lower; you might find a rate as low as 4.5% on a $36,000 car—if you have perfect credit. If you paid $4,000 down, you would have monthly payments of about $1,400.
For a 48-month loan, sometimes the lender charges the same interest rate as the 36-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 could easily start paying the minimum due to free up money for the emergency.
In the same loan scenario, you might pay around $729 per month with this loan, vs. about $950 with a 36-month loan—however, you'd pay about $800 more in interest with the 48-month loan.
60-Month or More Loans
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, try to 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.
At 60-month, 5.5% interest and a $4,000 down payment, monthly payments would be close to $611—but the interest paid shoots up to around $4,674.
The average term of 69 months, along with an average rate of 6.12%, makes the total amount paid for the vehicle $37,949—well over what the vehicle was worth brand new.
Some Final Thoughts
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 65 months.
Cars are becoming more and more expensive, which makes 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 keep control of your finances.