Part I: The Truth About Long Term Auto Loans
When poor credit and high monthly payments are keeping you from buying the car you need, it may be tempting to lower your payments by signing up for a 72-, 84- or even 96-month term loan. Before you do, it's important to know exactly what you're signing up for — and be sure you’re making the right move for your finances.
Lower car payments with longer terms mean you’re paying more in interest, and loan companies love this for obvious reasons. Evidently, consumers do, too. In the first quarter of 2017, new car loans with terms from 73 to 84 months represented 34.9 percent of all auto financing. For used cars, they represented 19.5 percent.
Most of the big dealerships offer 84-month financing through banks like Ally Financial or Santander. Local dealers are also known to offer longer term financing offers, typically through third party financing companies, credit unions, or insurers like Nationwide.
Let’s take a look at what you’re getting into when you choose a longer term on your auto loan...
Note: These numbers don’t include tax, title, or registration, which will only increase the amount of interest you pay if you include those costs in the total amount you borrow. These numbers also don’t include any down payment or trade-in you may have, which will decrease the amount of the loan and the amount of interest paid.
5 reasons long auto loan terms are a bad idea
- More interest. As you saw in the example above, you’re going to pay a lot more interest on a car loan with a longer term. If you spend more than those average amounts on a new or used car, the amount of interest you pay is only going to go up.
- Your loan will outlast your warranty. Most manufacturer's warranties last 3 to 5 years, so you’ll be paying on your loan for an additional 2 to 4 years after the warranty runs out. Which leads to…
- New car payment, old car repair costs. Think about this. You’re going to be making your car payment for the next seven years. With a shorter term, you’d have paid off your vehicle before you started paying for costly repairs. But with an 84-month loan, you’re going to be paying both your monthly loan and the inevitable repair costs that come with an older vehicle.
- Negative equity. Stretching out a car loan over time means you’re paying less on the principal and more in interest with each payment. As your vehicle continues to decline in value each year, you’ll continue to be upside-down on your loan unless you made a significant down payment.
- Unable to refinance. If you’re upside-down on your loan, meaning you owe more on your loan than the vehicle is worth, you’ll be unable to refinance your loan.
When it makes sense to get an 84-month auto loan
- You absolutely can’t afford a car any other way. This is probably the number one reason why people choose longer terms on their auto loan. An 84-month auto loan will lower your monthly payment, allowing you to purchase that vehicle that otherwise would be just out of reach. However, you should consider whether you’re borrowing too much if you can’t afford the monthly payment on a shorter term loan. Can you compromise by buying a used car at a lower price point? Or, could you scrounge up more money for a larger down payment to reduce the amount you need to borrow?
- You have higher interest debt to worry about. If you have other loans at a higher interest rate, it may make sense to get a lower monthly loan payment so you can free up capital each month. That way, you can use the extra money you’re saving to pay down higher interest loans.
How to make the most of a long-term loan
- Compare rates. Companies like LendingTree and MagnifyMoney allow you to compare auto loan rates from multiple lenders. So you can make sure you’re getting the best deal and a low APR. (Disclosure: LendingTree is the parent company of MagnifyMoney)
- Buy now, refinance later. If you’re absolutely bent on getting a certain car now, you can always choose to refinance down the road, when your financial situation improves.
- Make a larger down payment. Getting out of a bad car loan can be difficult when you’re upside-down. By putting more down on your vehicle up front, you’ll prevent this from happening while saving money in interest and avoiding gap insurance.
- Buy used. The average used car payment is $145 less than the average new car payment, according to Experian, so save yourself some money with a more affordable monthly payment by buying a used vehicle.
5 tips to lower your costs of borrowing
- Keep your car after it’s paid off. Once your car is paid off, keep it — especially if it’s reliable and gets good gas mileage.
- Make an extra payment each month. By paying an extra $100 per month, you could save $1,819 in interest and own your car in a little over five years when you buy a $30,534 new car with an 84-month loan. When it comes to that $19,126 used car, you’d save $1,598 in interest and pay it off in under five years.
- Compare rates. Shop around for the best rates, and get multiple offers from lenders to compare. A difference of 3 percent on your interest rate could save you $3,689 on that 84-month new car loan of $30,534 and $2424 on that $19,126 used car.
- Buy used. With used car payments an average of $145 less than new, you’ll save a lot when you buy used over new.
- Don’t finance extras. Pay up front for your license, tax, and registration. If you purchase an extended warranty or prepaid maintenance package, don’t finance those into your loan either.
Part II: Understanding the Auto Loan Process
Most people do it backward — they go shopping for a car first, then shop for a loan. When you do this, you’re making yourself vulnerable to high-pressure sales associates and putting yourself at a disadvantage when it comes to financing your vehicle.
When you get pre-approved for auto loans before heading to a dealership, you have an understanding of how much money you can qualify for, so you’re not shopping for vehicles that are too expensive. You also have a loan amount and interest rate to compare any other financing that’s offered to you.
How to get pre-approved for an auto loan
You can get pre-approved with a bank, credit union, auto finance company, or dealership finance center.
- Research rates online. Many sites, like MagnifyMoney's parent company Lendingtree.com, will offer auto loan rates online. It’s a good idea to check them out so you have an idea of what’s being offered. Keep in mind that your creditworthiness will affect the rates you’re able to qualify for, and the credit score for an auto loan is a little different from other loans.
- Gather your documents. Get everything you need together before calling or taking a visit to your lender. This may include:
- Personal information, like your name, address, phone number, and Social Security number.
- Employment information, like your employer’s name and address, your title and your salary
- Financial information, including what kind of credit you have available now, your current debts and your credit score.
- Apply. Choose a few lenders and apply online or in person for your auto loan.
- Get a quote. Once you’ve completed the loan application and you’ve been pre-approved, you’ll receive a loan quote showing how much you qualify for, the interest rate and the length of the loan. You can take this to the dealership with you when you’re shopping and use it as a negotiating tool.
For more information on your loan choices, check out these resources:
Getting a cosigner for an auto loan
Having a co-signer can help you qualify for a loan you wouldn’t otherwise get. As long as the co-signer has a strong credit score, it’s likely you’ll qualify for a better interest rate using a co-signer too. And making on-time payments on this type of loan will help build your credit.
The drawbacks of having a co-signer are that the cosigner is responsible for the loan if you fail to pay. If this happens, chances are you’ll negatively affect your relationship with whoever cosigned for you. If that’s a friend or family member, (which it usually is) look out! Think twice about the responsibilities of having a co-signer, and the importance of paying back the loan, so you don’t leave your cosigner on the hook for money you borrowed.
Understanding your auto loan contract
Here are some key terms you’ll need to know when it comes time to signing a contract.
- Sticker Price – A manufacturer's suggested retail price that is printed on a sticker and affixed to a new automobile
- Purchase Price – This may be less than the sticker price, and is the price you agree to purchase the vehicle for from the dealer.
- Amount Financed – This is how much money you are borrowing and the amount you’ll pay interest on. Be careful about financing extras into your loan, as doing so may put you upside-down in the vehicle.
- Down Payment – An amount of cash provided at the time of vehicle purchase and credited toward the purchase price of the vehicle to reduce the amount financed.
- Interest Rate – The amount of money charged for loaning money, expressed as a percentage of the Amount Financed.
- Fixed-Rate Financing – With a fixed rate, your interest rate will never change and you’ll always pay the same amount each month.
- Variable Rate Financing – A variable interest rate is subject to change and may increase your monthly payment amount.
- Monthly Payment Amount – This is how much you’ll pay each month.
- Finance Charge – This is a fee, charged by the lender, for extending you credit.
- Annual Percentage Rate (APR) – APR includes both the interest and fees expressed as a percentage, making it easier for you to compare multiple loan offers.
- Term — This is the length of the loan expressed in months, usually 36, 48, or 60.
- Extended Warranty Contract – An extended warranty covers the vehicle beyond the manufacturer's warranty for a fee.
- Guaranteed Auto Protection (GAP) – If you owe more than the car is worth, you’ll be offered GAP insurance, which will cover the difference if the vehicle is lost, stolen, or totaled.
- DMV Fees – These may include title, license, and registration.
- Title — The legal document proving ownership of a vehicle.
Auto loan contract traps
Here are few traps dealers can use against you. Know them so you can protect yourself and avoid getting ripped off
- Rate mark ups. Your dealer is getting financing from a bank, and they mark up the rate, charging you an extra percentage or two when you could have just gone directly to the bank in the first place.
- Yo-yo financing. The dealer says you’re approved and you drive away. Later, the dealer says you were denied, and asks for a larger down payment or increases the interest rate. If you refuse, you must return the vehicle, and the dealer may try to keep any deposit you made.
- Falsified credit application. Sometimes dealers will falsify information on your credit application, like increasing your income, to help you qualify for a vehicle you wouldn’t otherwise qualify for. Be sure to check your credit application before signing.
- Selling extras. Whether it’s GAP insurance, prepaid maintenance, or extended warranties, the dealership is going to try to upsell you on some extras to rack up the charges and, if you agree to roll it into your financing, increase the amount of interest you pay. Be careful when selecting these extras and make sure you understand what you’re getting and know it’s worth the expense.
- Negative equity financing. If you owe more on your trade-in vehicle than it’s worth, dealers will try to offer you a deal where you roll the negative equity into your new auto loan.
- Extra charges. Look over your contract for any extra charges. One way to spot these is if they’re pre-printed on the contract. Many of these charges are not required and can be negotiated down.
Using an auto loan to improve your credit
If you’re working toward improving your credit, there are two rules you must follow. And while going from good to excellent isn’t easy, there are a few ways your auto loan can help you improve your score.
- Payment history. On-time payments are 35 percent of your FICO score, so paying your auto loan on time will help with your payment history.
- Credit mix. Because having a mix of different types of credit (home loans, personal loans, credit cards) makes up 10 percent of your FICO, throwing an auto loan in there will certainly improve your mix.
- Report to credit bureaus. Make sure the lender you’re working with reports your payments to the three major credit bureaus. Beware of “Buy here, pay here” dealerships who may or may not report your payments to the credit bureaus.
And if you want to prevent your credit from getting worse, make sure you don’t do any of the following:
- Make late payments on your auto loan.
- Stop making payments and get sent to collections or have your car repossessed.
- Include your car loan in your bankruptcy (if applicable).
When it makes sense to lease vs. buy a car
If you’re taking out a longer term loan in order to lower the monthly payment, you may want to consider leasing as an option. There are some things you should know before leasing a car, especially if you’re comparing leasing to buying. And while leasing isn’t for everyone, it can be a viable alternative to taking out an 84-month lease. in fact, according to Experian data, the number of people taking out a lease continues to increase.
“Another reason why we see consumers increasingly choose to lease, is they’re generating around $100 lower payment. And the biggest difference is in non-prime, [where there’s a] $109 difference between a loan and a lease,” says Melinda Zabritski, senior director of sales at Experian.
The Pros and Cons of Leasing a Car
- Lower monthly payment. The payment to lease is an average of $100 less than buying according to Experian’s 2017 report.
- Warranty coverage. The average lease lasts 36 months and during that time, you’ll have full warranty coverage for anything that goes wrong with the vehicle.
- Mileage penalties. Most leases have a limit on how many miles you can drive (10,000 per year for an average lease), and you’ll pay for additional miles you drive unless you secure an extra-mileage or unlimited-mileage lease upfront.
- Wear-and-tear fees. Nicks, scratches, stains — they all amount to extra wear and tear on your leased vehicle, and you’ll pay for them at the end of your lease. So if you’re hard on your vehicles, buying may save you some money here.
The Pros and Cons of Buying a Car
- Ownership. Once you’ve paid off your loan, the vehicle is yours.
- No mileage penalties. Drive as much as you like, you won’t pay a dime for "extra" miles you drive like you would with a lease.
- Maintenance and repairs. With ownership comes responsibility. In addition to being responsible for the maintenance, once the manufacturer’s warranty expires, you’ll be responsible for all any repair costs needed. That’s why some people consider buying an extended warranty.
- Loss of value. Although you won’t pay fees for wear and tear, or extra miles you put on the car, those things will still lower the value of the vehicle when it comes time to sell it. And every year you own it, the value of the vehicle is likely to continue to decrease.
The Bottom Line: Is an 84-month auto loan ever a good idea?
In our opinion, no. Most people make the choice to take out a longer term auto loan in order to lower their monthly payments to afford the car they want. ‘Want’ being the operative word here. Chances are, you can purchase a less expensive car that would give you the same monthly payment. Although it’s difficult, putting your emotions aside can really help you make a financially sound decision when it comes to choosing the terms of your auto loan. If you know this is an area where you struggle, ask for help from a friend or family member who can be the voice of reason.
If you do choose to go with an 84-month auto loan, just understand that you’ll be paying more interest on your loan. And hopefully, you have a good job for the next seven years to help you pay for it.
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