Loan terms are important when buying a car because they affect your monthly payments and total debt. A longer loan term can mean cheaper monthly payments, but it usually means higher interest rates over the life of the loan and more time for the borrower to build equity.
This makes it more likely that you will be “upside down” on the loan, meaning that the value of the car could drop below the amount you owe. This can make it harder to sell or trade the car in the future. Down payments, loan terms, interest rates, and other expenses all have an impact on the overall cost of owning a car. This shows how important it is to understand all of these factors before agreeing to a loan.
1. Down Payment:
Your down payment for a vehicle impacts monthly payments and loan terms in various ways, whether made from cash, trade-in value, or both. A higher down payment reduces the amount that needs to be financed, resulting in lower monthly payments and better interest rates.
Avoiding being upside down can also help ensure that your loan remains manageable; otherwise, this could leave you owing more than what its true worth is, which could pose difficulties if you ever wish to sell the vehicle in question in the future.
2. Loan Term:
Loan terms refer to the duration of your car loan payment plan. Many lenders offer flexible payment terms ranging from 60 to 72 months that may reduce monthly payments while increasing overall interest costs. But bear in mind that longer loan terms generally come at greater expense in interest costs.
Lenders don’t give away money for buying cars out of generosity; you agree to pay back plus an interest rate fee (also called loan fees or rates). The longer you borrow, the greater will be your costs for owning it, so choose the shortest term possible that still leaves enough savings for other expenses.
3. Interest Rate:
Most car buyers must finance their purchase. Loan terms and interest rates can differ between lenders, making it important to compare available offers before making your decision. It pays to shop around to find the most cost-effective loans.
Longer loan terms often entail paying more interest. While buyers may enjoy lower monthly payments with extended loan terms, lenders usually charge higher interest rates to compensate for increased risk. An annual percentage rate (APR) represents the cost of borrowing expressed as a percentage and includes lender fees.
4. Fees:
Longer car loan terms offer lower monthly payments but can cost thousands more in total interest payments due to lender risk—they increase the chance that something could prevent them from collecting their money back.
Save for a down payment before financing the full purchase price to ensure a lower borrowing cost and more vehicles within your budget. Compare loan terms to determine what best fits your situation.
5. Trade-In:
Your loan amount depends on the loan term and whether it’s for a new or used car purchase. A longer repayment schedule could reduce monthly payments but may incur more interest charges.
If your trade-in value falls short of your auto loan payoff amount, this will result in negative equity for the vehicle. Your options include either paying off any remaining loan balance before trading in or rolling it over into another loan agreement, though this latter option could put you into negative equity on that loan too.
6. Depreciation:
Over time, the value of any car declines with age, mileage, and wear and tear. This loss in value is known as depreciation. If the value of your car declines faster than you can pay off its loan, negative equity may develop. This financial strain may create difficulty when selling or collecting on an insurance policy policy.
Consumer preferences and market trends play a large part in determining how quickly cars depreciate. Fuel-efficient cars tend to lose value at a slower pace.
7. Taxes:
Car prices include both the costs associated with owning it as well as interest payments to compensate lenders for risk and opportunity costs associated with lending you money for its purchase. You’ll find the interest rate listed on your loan paperwork, as this factor plays a key role in determining its length.
Policymakers are considering offering tax breaks for car loan interest, which would increase demand and potentially cause prices to go up in certain cases. According to estimates by The Budget Lab, its initial-order static ten-year budget cost would total around $173 billion.
8. Insurance:
As the average new and used car loan exceeds $39,721 according to Experian, more people are opting to finance their vehicle rather than pay in cash upfront. Unfortunately, this comes with an enormous financial commitment, which can be hard to manage without understanding basic auto loan terms.
The term of your car loan makes a substantial impactful difference on monthly payments and interest charges. Selecting a longer loan period may allow you to afford higher-priced vehicles more easily, but may cost more in total over time. Adding extra features can further add to the total loan amount.
9. Dealer Fees:
Dealerships usually charge a document fee to cover the costs associated with filing paperwork and filing it with the state. While some states impose limits on this charge, others don’t; either way it can be negotiated down further to reduce or remove this expense from your final sale price.
Before making any commitment, always review the window sticker of a car you intend to buy for its total cost, including fees such as doc and state sales taxes. Use this data to compare prices across dealers.
10. Payment Schedule:
Your loan payment includes both principal and interest. A car loan calculator can help you visualize how these two components make up your scheduled monthly installment.
Assuring yourself of the terms of your loan can help you select more affordably priced cars and manage payments more easily. A larger down payment could potentially shorten the loan term or shorten payments, potentially decreasing total costs significantly.
