Picking out the car of your dreams is just the choice you have to make before you can drive off the lot - you still have to figure out how to pay for it. If you're financing your car, you'll have to decide how long you want to commit to a loan. Car loans typically run from 24-months to 84-months, increasing in one-year increments, with the average loan spanning about five and a half years, according to Autotrader.com.
Advantages of short-term loans
When you choose a car loan with a short term, you minimize the total cost of the loan. First, you're borrowing money for a shorter period of time, so less interest will accrue on your loan. Second, loans with shorter terms also tend to have lower interest rates overall, so not only do you pay interest for a shorter period of time, you also pay it at a lower rate.
Disadvantages of short-term loans
The downside to a short-term auto loan is that you'll have higher monthly payments than if you opt for a longer term. For example, say you're borrowing $20,000 at 4 percent interest. If your loan as a 36-month term you pay $590 per month. If your loan term is 72 months, your monthly payment drops to $313. Because the monthly payment is larger, you might not be able to spend as much on the car as you want with a short-term loan.
Advantages of long-term loans
When you opt for a shorter term on your auto loan, you're locked into making higher payments than you would with a longer-term loan. With a long-term loan, you can buy a more expensive car and still have the monthly payment fit in your budget. Additionally, unless your loan uses pre-computed interest - which is when the interest payments are fixed, regardless of when you make the payments - or imposes an early payment penalty, you can pay off the loan early if you have extra cash.
Disadvantages of long-term loans
The biggest disadvantage of a long-term loan is that you'll pay significantly more over the life of the loan. Remember the $20,000 loan comparison at 4 percent over three years versus six years? On the three-year loan you'll pay $1,250 in interest. On the six-year loan you'll pay over $2,500 in interest, which is more than double the interest on the three-year loan. In addition, cars decline in value over time; an average of 22 percent just within the first year, according to Autotrader.com. With a long-term loan, you could find yourself owing more on your car then it's worth.