As the prices of new cars are skyrocketing, more and more car shoppers are choosing to purchase a used car for the lower price tag and to bypass the high depreciation. New car buyers pay an average of $37,000 according to Kelley Blue Book, while the average used car buyer pays around $20,000. Although buying used is a wise financial decision, it’s essential to finance the vehicle the right way to reap the benefits. We’ll cover the average length of a used car loan, the drawbacks of stretching out the loan, and how to set yourself up for success when financing a used car.
Used Car Loan Terms
With the rising costs of both new and used vehicles, it comes as no surprise that used car buyers are extending their car loans for as long as 84 months (7 years). Long-term car loans, which are defined as loans over 5 years, allow the borrower to get lower monthly payments for a longer period of time which makes it possible for them to buy the vehicle they want. According to Experian, 42.1% of used-car shoppers are taking out car loans between 61 and 72 months while 20% go even longer, financing between 73 and 84 months.
Experian reports that the average used-car loan term for 2019 is 65 months which falls into the long-term category at over 5 years. The reasons that used car buyers go with longer-term loans can range from the temptation for a nicer or newer vehicle to the salesman convincing them it's a good idea. Of course, long-term loans offer the benefits of more manageable monthly payments, but is it worth the drawbacks? We'll cover what those are so you can decide for yourself.
Drawbacks of Long-Term Car Loans
While you'll save money on the purchase price of your used vehicle if you compare it to new, you'll also find higher interest rates on the used car loan. This is because lenders determine your rate based on factors such as the risk they incur by lending to you. Compared to new cars, the value of used cars (the collateral when it comes to the lender) is less defined. There is also a higher risk of the borrower defaulting on the loan. The best way to keep your interest rates as low as possible is to avoid long-term loans which bump up the interest rate even more.
Over the course of the loan term, you may end up overpaying by thousands of dollars in interest. For example, if we looked at a borrower who financed a used truck for $30,000 for 4 years and one who chose to finance for 7 years. By going with the longer loan, the borrower gets a higher interest rate and ends up paying nearly $4,000 more than they would have with the shorter-term loan.
Other than throwing money away on the loan itself, another concern to be wary of long-term loans is that you will be more likely to be upside down on your car loan, meaning you owe more on your car than it is worth. Although you won't incur the depreciation of new cars, stretching out a used car loan for over 5 years puts you in danger. If you lose your source of income or experience a sudden change in your finances and can't make payments, you won't be able to remedy the situation by selling the vehicle.
Tips for Financing Your Used Car
Sometimes you have no choice but to finance a vehicle for longer than 5 years. To avoid getting yourself into an upside-down car loan and a cycle of debt, you should do the math prior to going in to buy the vehicle. This includes finding a vehicle that fits your budget and financing it wisely.
First, determine a comfortable monthly budget and choose an affordable car that fits that number. When deciding on the loan terms, go with the shortest possible length that fits your budget. While most lenders will be happy to accommodate loans up to 84-months and some dealers will even push these terms on you, you shouldn't jump at the first financing offer.
Along with determining your budget for the monthly payment, think long-term and make sure you're getting your best possible interest rate. The best way to do this is by getting pre-approved for auto financing which lets you see offers from multiple lenders and gives you the power to move forward with the best option. You can apply for financing at the dealership, but it pays to shop around at your bank, credit union or with online auto lenders. You may find these options offer lower rates and are more likely to accept borrowers with less than perfect credit.