Although longer terms for auto loans allow borrowers to make reduced monthly repayments, they come with several downsides that we think you should know about. Read this article to understand the various reasons to avoid borrowing a long-term auto loan.
1. High Total Costs
As mentioned, many borrowers are tempted to choose long-term auto loans as they offer lower monthly repayments. However, there is a catch. You will likely pay more interest if you take a long-term auto loan.
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For example, if you obtain an auto loan of $28,000, payable within 72 months with an 11.3% interest rate, you will pay $537 every month for six years. At the end of the loan repayment period, the total interest will be $10,714.
If you obtain the same loan amount but payable within 96 months (8 years), the interest to be paid will be $14,704. So, the six-year loan will help you save roughly $4,000. In other words, a shorter loan term will allow you to save more.
2. High Interest Rates
Most financial institutions charge considerably high interest rates for long-term auto loans as they believe they carry massive risks, given that the value of cars, which serve as collateral, depreciates over time.
When interest rates on auto loans are higher than usual, they increase the repayable amount. As such, taking a short-term auto loan is advisable.
3. Negative Equity
If your car is worth less than the loan amount to be repaid, it means that the equity in that car is negative. As stated earlier, A car’s value declines over time. According to recent research, cars lose 15% of their value within the first 12 months and 75% after five years. Therefore, the more time you spend servicing a loan, the higher the chances of having a negative equity in your car.
Negative equity comes with numerous problems. For instance, if you want to cash out your car before completing loan repayments, it is likely that you won’t get sufficient money to pay off your auto loan, forcing you to draw funds from other sources.
4. Limited Flexibility
Once you tie yourself down to a long-term auto loan, your ability to explore other alternatives with fair interest rates will be limited. Note that some auto loan lenders may impose penalties when you wish to get out of your loan early to seek alternatives.
5. Repair and Maintenance Costs
When taking an auto loan, monthly payments should not be the only costs to consider. Instead, factor in expenses related to car repairs and maintenance. As the value of your car depreciates, the more work it requires, thus increasing maintenance costs. So, you might struggle financially if you hold a car for, say, 96 months while serving your loan and paying maintenance bills.
Alternatives to a Long-Term Auto Loan
Leasing Rather Than Buying
Instead of applying for a long-term loan, you can lease a car and pay monthly payments in exchange. There is a chance that the monthly payments for leasing are relatively smaller than those required for a long-term auto loan. However, the disadvantage of leasing is that you do not accumulate equity in the leased car. Also, once the lease agreement ends, you do not own that car.
Get a Co-Signer
You may not get an auto loan with a favorable interest rate if your credit score is low. Therefore, consider finding a co-signer with good credit to apply for an auto loan alongside you. That way, the lender can lower the interest rate and grant you a car loan at favorable terms.
Is It Possible to Refinance an Auto Loan?
Yes! It is possible to refinance your auto loan. This may lower monthly payments and the interest rate. However, before refinancing your loan, learn whether the lender of your old car loan charges prepayment penalties. Also, calculate first how much you will save by refinancing your loan.