“The trade-off is essentially cash‑flow relief today versus higher financing costs over time, and that balance matters more in a higher‑rate environment,” Keating says.
5 tips for deciding your auto loan term length
“The right term length depends on how long you expect to keep the vehicle and how much flexibility you need in your monthly budget,” Keating explains.
1. Determine your funding needs and limit
Consider your down payment, trade-in value and new vehicle price to determine how much to borrow. Most experts recommend spending no more than 15% to 20% of your monthly income on a car payment. This benchmark can help you set a budget when researching vehicles.
2. Get preapproved and compare lenders
Getting preapproved for a car loan can help you estimate rates and streamline your purchase experience. It also shows you the terms you are likely to qualify for and your approximate monthly payment. Compare offers from multiple lenders to find the best terms.
3. Avoid the risk of developing negative equity
Negative equity occurs when you owe more on your vehicle than it is worth. Cars depreciate quickly, so you’re more likely to be upside down early in your loan term. This is especially true on longer loans, where it takes longer to pay down your principal.
“Shorter loans generally make sense for buyers who can comfortably handle a higher payment and want to minimize interest expense and negative equity,” Keating says. “Longer loans can be helpful for managing monthly cash flow, but they keep borrowers in the loan longer and can increase the risk of owing more than the vehicle is worth, especially early in ownership.”
4. Gauge how long you plan to keep the car
How long you intend to keep your car might also affect your choice of loan term. Selecting a long term means you need to drive your vehicle for an extended period or pay off negative equity with a new loan. If you prefer to change cars frequently, a shorter term might make more sense.
Choosing a shorter loan term might also benefit you in the long run. Keeping your vehicle past loan repayment can free up funds for other expenses.
5. Calculate monthly and total borrowing costs
An estimated monthly payment doesn’t provide a transparent view of your total borrowing costs. Zeroing in on the first number and overlooking the second can lead to spending beyond your means.
“A good rule of thumb is to focus on total cost, not just the monthly payment, and to avoid stretching the term so far that it limits your flexibility when it’s time to trade or sell,” Keating advises.