The seven-year car loan is becoming more popular among consumers who buy new cars, according to a recent survey by Experian, one of the three major U.S. credit bureaus. The finding raises concerns because the longer the term, the more interest consumers will pay over the life of the loan.
Since a longer loan means a higher effective cost of the new car, you might expect consumers to shy away from them. But Experian’s data showed otherwise.
In the second quarter of this year, nearly 16 percent of new-car financing loans had repayment terms of 73 to 84 months, up from about 15 percent in the previous quarter. Meanwhile, the average repayment term for a new-car loan is 64 months, up from just 63 months in 2008.
A borrower who applies for a 5-year car loan for $25,000 at 4.50 percent APR will have monthly payments of $466 and pay $2,960 in total interest. A 7-year loan for the same amount at the same interest rate will have monthly payments of $348 and $4,232 in interest.
The monthly payments for a 7-year loan are lower, but they come at a cost of $1,272 in extra interest paid over the life of the loan.
As lenders start to lend again, after tightening underwriting standards following the financial crisis, dealerships are more likely to offer longer-term loans. If you are on the market for any car, here’s how you can prevent yourself from being lured by the 7-year loan:
Maximize your credit score.
When you apply for a car loan, your credit score is going to be used to determine the terms of your loan. With a higher credit score, you are more likely to get lower borrowing rates and better terms. It’s also a personal credential that gives you leverage when negotiating an agreement with the dealership.
Put down as much cash as possible.
Like any loan, paying with more cash will leave you with a smaller principal, and possibly lower rates. Since you’ll owe less from the beginning, you’ll be less inclined to take on a long-term loan. The financial benefits add up when you get a lower rate and you start off with a lower loan balance. Monthly payments are also more likely to be lower.
Set a maximum price for your car purchase.
A salesman’s aggressive mode of operation is no secret when it comes to selling cars, and that tenacity extends to financing options, too. Consumers who express concerns over their ability to afford a nicer model will cause car salesmen to push long-term car loans. They will use the lower monthly payments to convince you that it is possible to own the latest model without having to live on rice and beans for the next several years. By establishing a limit to your new car purchase, you close the doors on the possibility of larger financial burden.
Calculate the final costs of the loan.
Take the time to determine the total costs of loans with different repayment durations. The difference between these final costs will play a major role in dissuading you against the longer-term option. After all, if you perform your due diligence, you could end up saving thousands of dollars in the long run.
Simon Zhen is a columnist and staff writer for MyBankTracker.com. His columns cover all aspects of personal finance—with a particular emphasis on bank rates, products, and services.