Choosing an auto loan for your new car is a big decision. It can affect your monthly finances, your credit, and your ability to sell the car down the line.
The most common auto loans are 3-year loans and 5-year loans. Here are the benefits and drawbacks of each:
3-Year Auto Loan
Benefit: These loans are less expensive overall. They are less risky for the lender, so they carry a lower interest rate. If you anticipate having a very solid income for the next three years, a 36-month plan will save you money over the course of the loan. It will also allow you to pay off your car faster, meaning you can resell it sooner. That is a significant benefit since cars depreciate quickly.
Drawback: 3-year plans come with a higher monthly cost. This can eat into your monthly budget. Even if you can afford it now if your financial future is uncertain—if you know you’ll be looking for a job in six months, for instance—you may not want a 3-year loan. These expensive monthly payments leave you less discretionary income to handle life’s uncertainties, whether it’s unemployment or unexpected medical bills. You cannot eliminate these uncertainties, but if you anticipate having them, a high monthly payment might not be your best option.
5-Year Auto Loan
Benefit: 5-year loans spread payments out over an extra two years creating lower monthly payments. With lower monthly payments, 5-year auto loans leave you more discretionary income to pay down other debt, save more, or just enjoy life! A 5-year loan is usually more affordable month to month.
Drawback: These loans cost more overall. 5-year loans tend to have higher interest rates. You are also paying over a longer period of time, which magnifies the cost of compound interest. Real Car Tips notes that if you buy a $20,000 car, even if your interest rate stays the same, you may pay around $1537 more in interest on a 5-year loan than on a 3-year loan.
Beware: Dealers often use the prospect of longer loans to try to push clients into more expensive cars, because many customers only look at their monthly payment. This is dangerous. If you end up buying more car than you can afford, you can end up underwater (owing more than the car is worth)—which will hurt your ability to resell the car.
Should you ever take out a loan of more than five years? Probably not. First, the interest will be higher. Second, you want a loan that is significantly less than the length you plan to keep the car, so when you sell it you don’t owe money to the credit union. Because cars depreciate quickly, if you want to resell it, you should do sooner than later. The average life of a car is about 9.4 years, so a loan of more than 5 years can leave you unable to sell for most of the car’s life.
If you are considering an auto loan and would like additional advice, give us a call at (303) 458-6660. During the month of February, an RMLEFCU Auto Loan means NO PAYMENTS FOR 90 DAYS! Talk to one of our loan specialists to learn more.