Longer financing terms are becoming more popular. According to J.D. Power Canada, 51% of car buyers financed their new car for 84 months (7 years) or longer in 2018. A decade ago, long-term financing was the minority with less than 40% of car buyers choosing a loan that was 72-months or greater.
Longer loan terms come with advantages and disadvantages when buying a used car.
The components of a car loan
A car loan has three main components: principal, interest rate and term. The decisions you make about each component when negotiating your loan will have an impact on your monthly car payments.
The principal is the amount of money you’re borrowing, the interest rate is the amount you are charged to borrow said money, and the term is how long you have to pay back what you borrowed. In this post we’re going to focus on the last piece: the term.
Why does the length of a loan matter?
You might think the longer you have to pay back a loan the better, right? Not necessarily. Choosing the maximum financing term will make for lower monthly payments because the amount is spread out over a longer period of time. But, you will also end up paying more in interest thanks to those added months.
Advantages of long term financing for a used car
1. You will have lower monthly payments
This is the biggest benefit of choosing a longer loan term. The longer you have to pay off the debt, the lower each monthly payment will be. If you don’t have much room in your budget, but are in need of a car a longer loan term can help get you in the driver’s seat.
2. You can afford a more expensive car
If your monthly budget doesn’t cover the cost of your dream car, a longer loan term can help you afford it. For example, if you can afford $200 a month, you’ll be able to buy a $7,200 car with a 36-month loan. With that same $200 a month budget financed over 84-months, you can suddenly afford to buy a $16,800 car.
Disadvantages of long term financing for a used car
1. You spend more on interest
For car loans, the interest is charged on a monthly basis so each month you add to your loan term is extra money spent on interest. Also, long term financing can come with higher interest rates because it’s a bigger risk for the lender. These extra charges could equate to hundreds or thousands of dollars.
2. It’s easier to get upside down
New cars depreciate faster than used cars, which can make it easy to get upside down on a car loan — a phenomenon that happens when your car is worth less than you owe on your loan. While less common, this can also happen with used cars when the financing term is really long. If you are upside down on your loan when you try to sell your car you will end up losing money on the sale.
3. It takes longer to pay off the car
It seems obvious, but the longer your financing term the longer you’ll be making payments on your car. When you’re negotiating the term of your loan, ask yourself if you really want to be making payments on this car six or seven years down the road. Also, depending on where you get your financing you might not be able to pay off the loan early.
Generally speaking, longer loan terms are more beneficial for the lender (because they make more on interest) and shorter loan terms are more beneficial for the borrower (because you will save money in the long run).
Car loans come in all shapes and sizes for people with any kind of credit situation. If you have bad credit it’s important to choose a lender you trust. Birchwood Credit Solutions specializes in bad credit car loans and our knowledgeable Finance Managers can help you secure financing that fits your budget. Give us a call today or stop by one of our three Winnipeg locations.