When it comes to buying a car, many of us will consider financing options to help spread the cost. One of the most important aspects to understand when financing a car is the term of the loan, or how long you will be paying it off. The average car finance term has a significant impact on your monthly payments, the total interest paid over the life of the loan, and your overall financial picture.
In this article, I will walk you through the concept of the average car finance term, the factors that affect it, the pros and cons of different finance terms, and provide practical examples to help you make an informed decision.
Table of Contents
What is the Average Car Finance Term?
The finance term is simply the length of time over which you agree to repay the loan. It is usually measured in months, and for car loans, the terms typically range from 24 to 84 months. This means that you could be paying off your car loan over two years to seven years.
The average car finance term in the United States, for example, has been creeping upwards in recent years. As of recent reports, the average finance term for a new car loan was around 72 months (6 years).
Why Does the Car Finance Term Matter?
The finance term plays a crucial role in determining your monthly payments and the total amount of interest you pay over the life of the loan. Shorter terms tend to have higher monthly payments but lower total interest costs, while longer terms generally offer lower monthly payments but result in higher overall interest payments.
Let’s break this down with a few examples to see how the length of the loan term can affect your finances.
Example 1: Short-Term vs. Long-Term Car Loan Comparison
Let’s assume you are purchasing a car worth $30,000 and taking out a loan at an interest rate of 5% APR. I’ll compare two different loan terms to see how the finance term impacts the monthly payments and the total interest paid over the life of the loan.
| Loan Term | Monthly Payment | Total Interest Paid | Total Amount Paid |
|---|---|---|---|
| 36 months | $899.33 | $3,577.89 | $33,577.89 |
| 72 months | $483.32 | $6,799.06 | $36,799.06 |
In this example, with a 36-month term, your monthly payment is higher at $899.33, but you pay a total of $3,577.89 in interest over the life of the loan. However, with a 72-month term, your monthly payment drops to $483.32, but you will end up paying $6,799.06 in interest.
The long-term loan results in a lower monthly payment, but it costs you more in interest, and you end up paying more for the car overall. So, the length of the loan directly impacts both your monthly payments and the total amount paid for the car.
Factors That Influence Car Finance Terms
When deciding on the car finance term, several factors can influence your choice. These include your budget, income, credit score, and the type of car you are purchasing.
- Your Budget and Monthly Payment Affordability One of the most obvious factors is how much you can afford to pay each month. If you’re trying to keep your monthly payments as low as possible, you might lean toward a longer-term loan. However, as shown in the previous example, this will increase the total amount you pay over the loan’s life.
- Interest Rates Lenders often offer lower interest rates for shorter loan terms because they consider these loans less risky. If you can afford the higher monthly payments, a shorter-term loan can save you money on interest.
- Credit Score Your credit score plays a significant role in the terms you are offered. Those with higher credit scores tend to qualify for better rates, regardless of the loan term. If you have a lower credit score, you might be offered a loan with a higher interest rate, and in some cases, a longer loan term to make the monthly payments more affordable.
- Type of Car Whether you are buying a new or used car can also affect the finance term. New cars typically have lower interest rates and longer finance terms available, while used cars often come with shorter terms and higher rates.
Pros and Cons of Different Car Finance Terms
There’s no one-size-fits-all answer when it comes to choosing the right car finance term. Each option comes with its own set of advantages and disadvantages.
Shorter Car Finance Terms (24-48 months)
Pros:
- Lower total interest: With a shorter term, you’ll pay less in interest because you’re repaying the loan faster.
- Faster equity build-up: You own a larger portion of the car’s value sooner, which can be helpful if you want to trade it in or sell it.
- Lower risk of owing more than the car is worth: With a shorter term, you reduce the chances of being “upside down” on your loan, where you owe more than the car is worth.
Cons:
- Higher monthly payments: Shorter terms mean higher monthly payments, which can strain your budget if you have other financial obligations.
- Smaller loan amounts: Because the monthly payments are higher, you may not qualify for as large of a loan, limiting the type or brand of car you can afford.
Longer Car Finance Terms (60-84 months)
Pros:
- Lower monthly payments: A longer term spreads out the cost of the car over a longer period, making the payments more affordable.
- Ability to afford more expensive cars: Since the payments are lower, you might be able to afford a more expensive vehicle than you could with a shorter loan term.
Cons:
- Higher total interest: The longer you take to pay off the loan, the more interest you’ll pay overall. This could end up costing you thousands of dollars more over the life of the loan.
- Risk of being upside down: With a longer loan term, it’s easier to owe more than the car is worth, especially if the car depreciates faster than you pay down the loan.
Key Considerations When Choosing a Car Finance Term
As you decide on the right loan term for your car purchase, there are several key factors to keep in mind:
- Affordability: Can you afford the higher monthly payments that come with a shorter term, or do you need the lower payments offered by a longer term?
- Long-Term Costs: Do you want to minimize the amount you pay in interest over the life of the loan, or is it more important for you to keep your payments low in the short term?
- Future Financial Plans: How long do you plan to keep the car? If you plan to trade it in within a few years, a shorter term might be better to avoid being upside down on the loan.
Example 2: Long-Term Loan with a Trade-In
Let’s consider a scenario where you take out a 72-month loan for a $30,000 car but plan to trade it in after 3 years. Assuming the car depreciates by 20% over three years and you still owe $25,000 on the loan, here’s how it would play out.
| Car Price | Depreciation (20%) | Value After 3 Years | Loan Remaining | Balance After Trade-In |
|---|---|---|---|---|
| $30,000 | $6,000 | $24,000 | $25,000 | -$1,000 |
In this case, after three years, you would still owe more than the car is worth. This is a significant risk with longer-term loans and highlights why shorter terms can be a better option if you plan to upgrade frequently.
Conclusion
The average car finance term plays a crucial role in shaping your financial situation. Understanding how the length of the loan affects your monthly payments and the total interest you’ll pay is vital when making your decision. A shorter term offers quicker equity build-up and less interest, but it comes with higher payments. On the other hand, a longer term can provide more affordable monthly payments but could result in paying significantly more in interest.
Ultimately, the best car finance term depends on your personal circumstances, financial goals, and preferences. Carefully weigh the pros and cons of each option, and make sure to factor in all costs associated with the loan to make the best decision for your situation.
