The average price of a new car now exceeds $50,000, and more buyers are extending financing terms to lower their monthly payments.
The average loan term is now 69 months, and the proportion of 84-month loans is at an all-time high of 22%, according to data from automotive research firm Edmunds. Mr. Edmunds recommends a maximum of 60 months, but this is no longer realistic for many buyers with high price tags, making it difficult to pay for short-term contracts.
While longer loan terms can lower your monthly costs, they can end up costing you more overall and come with other drawbacks that are worth considering. Here’s a look at some of the tradeoffs.
higher overall costs
Extending the term of your car loan will lower your monthly payments, but it will also increase the total amount of interest you pay. For a $50,000 new car with a 10% down payment and the current average percentage of 7%, the additional costs are:
48 months: Monthly payments of $1,078, total interest of $6,724 60 months: Monthly payments of $891, total interest of $8,463 84 months: Monthly payments of $679, total interest of $12,050
The 84-month loan term costs $5,326 more in interest than the 48-month option.
Although this example uses a single APR for comparison, it’s important to consider that long-term loans tend to have higher annual interest rates than short-term loans, said Ezra Peterson, vice president of car app Way.com. “It’s almost a full and a half point higher in many cases,” he says.
Another risk is that “setting budgets based on monthly payments could lead people to buy more cars than they actually need,” said Justin Fisher, an auto analyst at car shopping website CarEdge.com. By focusing only on monthly costs, buyers may overlook how quickly total interest can add up.
end up with more debt
A longer loan term can leave you with less room in your budget in the future, especially since you may not know what your expenses will be by the time your loan is half paid off.
“Long-term debt is my biggest concern,” says Robert Perschitte, a certified financial planner with Delagify Financial. “If you continue to make payments on your car long after the warranty has expired, you run the risk of paying for repairs and other issues while making payments on your car. This one-two punch would be a huge blow to most budgets.”
A longer repayment schedule also means you have less flexibility if your income changes, you need to replace your car sooner than expected, or other financial needs arise.
Depreciation becomes a bigger risk
New cars depreciate quickly, which can pose additional risks for buyers with longer loan terms.
If you need to sell your car after it’s value has declined, or “if you sell your car outright due to an accident during the first few years of your 72-month loan, your insurance coverage or proceeds from the sale may not cover the remaining balance,” Fisher says.
Gap insurance, which covers the difference between the car’s value and the loan balance, can help offset the cost, but “in some situations, drivers can end up owed money for a car they no longer drive,” Fisher says.
Fischer said extending the loan term lengthens the repayment period and “gives the borrower a wider period of distress.”
Want to level up your AI skills? Sign up for CNBC Make It’s new online course, “How to use AI to better communicate at work by Smarter by CNBC Make It.” Get specific prompts to optimize your emails, notes, and presentations for tone, context, and audience.
Plus, sign up for the CNBC Make It newsletter for tips and tricks to succeed at work, money, and life, and request to join our exclusive community on LinkedIn to connect with experts and colleagues.
