What is the best auto loan term length?
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UPDATED: Apr 29, 2013
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Experts recommend limiting your car loan term to 48 months or less, but there are some benefits to choosing a longer term length.
In the last quarter of 2012, the average duration of an auto loan term was 65 months, or nearly five and a half years. Seventeen percent of auto loans issued that quarter lasted 73 to 84 months. These longer, subprime auto loans are a result of increased competition among financers to draw in more customers and increase profits. Longer auto terms mean smaller monthly payments for borrowers and bigger pay outs for financers.
Longer auto loan terms give borrowers the opportunity to buy pricier cars without dramatically increasing their monthly payment. The downside is that longer terms raise the overall cost of ownership.
The best auto loan term length
Mike Sante of Interest.com holds that four years, or 48 months, is the ideal auto loan term duration. In an interview with loans.org, he recommended following the 20/4/10 rule.
To determine how much a borrower can reasonably spend on an auto loan, she should budget a 20 percent down payment, plan for an auto loan term of four years and plan to spend 10 percent of her monthly gross income on payments. When borrowers agree to auto loans with terms at or exceeding 60 months, odds are they’re buying too much car.
Depreciation is another factor to consider. When borrowers extend their loan terms, they are essentially making a bad investment. As time goes on, the depreciation costs of a vehicle go up. After a mortgage, a car is the most expensive bill most consumers have. Devoting five or six years to paying for something that will only retain a fraction of its value isn’t a good idea.
“Buying a car is not an investment,” Sante said. “You don’t want it to drive all of your financial decisions.”
The pros and cons of long and short terms
Though longer auto loan terms aren’t recommended, there are some benefits to choosing them. Long-term loans make expensive models more affordable for your average borrower. This benefit doesn’t outweigh depreciation and interest costs, however.
Short-term loans have more perks, including lower depreciation costs, lower interest costs and better interest rates.
“Usually, the shorter the term length, the lower the interest rate,” Sante said.
In today’s market, however, auto loan interest rates are at historic lows and averaging around four percent.