The Long & The Short of Automobile Financing

Read Time: 3 minutes

How long should a vehicle loan last? That’s usually not the first question buyers ask when financing a car, pick-up or SUV, but different loan terms can produce savings worth thousands of dollars.

We often think of auto loans in terms of 60 or 72 months. According to Edmunds, in the fourth quarter of 2023, the typical new-car loan was 67.8 months in length, a little more than five-and-a-half years. Used vehicles were financed over 69.9 months.

The catch is that not all loan terms work equally well for all car buyers. Some may prefer shorter financing, while others may benefit from longer terms. You have to look at your situation to see which option is best for you. 

Short Auto Loans Versus Longer Vehicle Financing

Let’s look at a $36,000 loan. At 7% interest over 60 months, the payment is $712.84. The total loan cost is $42,770. The interest expense is $6,770.

The same loan over 72 months – six years – has a monthly cost of $613.76. That’s a cash savings of $99.08 a month or $1,189 a year. Bigger loans, of course, will produce even larger savings.

The catch is that while the monthly cost is lower for the longer loan, the interest expense is higher — $44,191 over 72 months versus $42,770 for financing with a 60-month term, a difference of $1,421. (You can look at different financing options by using the Refi.com auto-loan calculator. The calculator is free, and your email address is not required.)

This example raises several questions for auto borrowers.

Are you willing to pay a higher overall cost for a longer loan? The benefit is a smaller monthly cost.

Have you considered all financing costs? On the plus side, borrowers are likely to make a down payment and may get credit for a trade-in or rebate. More down can lead to a lower interest rate because the lender has less risk. On the minus side, in addition to the vehicle’s cost, there are likely to be charges for state sales taxes, tags, etc.

Have you looked at monthly cash flow? A longer loan will have a lower monthly cost, but a shorter loan can produce cash savings at the end of the loan term.

In our example, there are 12 fewer payments with a 60-month loan when compared to financing over 72 months That eliminates 12 payments of $613.76 per month, a total of $7,365 in cash payments, and a big deal for many household budgets.

Auto Loans and Home Mortgages

Are you trying to finance or refinance a home now or in the future? The reason to ask is that how you finance a car can influence your ability to get a mortgage.

It works this way: When you apply for a mortgage the lender looks at your debt-to-income ratio (DTI). This is a comparison of your monthly income and your required monthly debt payments for such things as housing costs, credit card bills, student loans, and auto financing. 

A higher monthly car payment will push up your DTI. If the DTI is too high, a mortgage lender might look for “compensating” factors such as a high credit score or solid savings to offset high monthly payments. However, there’s only so much “give” with DTI requirements, and too much monthly debt can cause a lender to decline a mortgage application.

Three Ways To Reduce Auto Financing Costs

There are several steps borrowers can take to reduce auto loan costs.

There are lots of ways to buy cars today, including through local dealers and online sites, so be sure to shop around. In the case of auto purchases, borrowers should look for the best available deals for the vehicle they want and the best available financing.

These can be seen as separate transactions. For example, you might get financing from Lender Smith and use that money to buy a car from Dealer Jones.

The rate you pay for vehicle financing depends in part on your credit score. Credit scores depend on the information found in your credit report. You can get free copies of your credit report from the three major credit reporting agencies (CRAs) — Equifax, Experian, and TransUnion — at AnnualCreditReport.com. If you see any errors or out-of-date items contact the CRA immediately.

Lastly, within the bounds of your finances and personal preferences, it’s often good to put more down.

“It’s a good idea to make a down payment of 10 to 20%,” according to Equifax. “However, generally speaking, the more you can put down, the less interest you’ll pay in the long run. The trick is to balance what you would like to pay with what you can reasonably afford. There’s no point in splurging on a large down payment that’s going to throw your budget off for months.”

Peter G. Miller

Peter G. Miller is a nationally-syndicated columnist, the author of seven books published originally by Harper & Row (including one with a co-author), and has contributed to leading online sites and major print publications. He has appeared on numerous media outlets including the Today Show, Oprah!, CNN, and NPR.

Peter has been an accredited correspondent on Capitol Hill and a member of the White House Correspondents Association. He has served with the District of Columbia National Guard and holds both BA and MS degrees from The American University in Washington, DC. View Peter on LinkedIn.

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