What is the Best Car Loan Term?
Long-term or short-term? One of the most important considerations when taking out a car loan is its term or the length of time you’re bound to repay the entire loan amount with interest. Also called “tenure”, the car loan term affects the loan’s interest rate and monthly repayment amount.
The term of a car loan usually lasts around 1 to 7 years. In Australia, the average tenure is around 72 months (6 years), followed by 84 months (7 years).
Both long- and short-term car financing have benefits and advantages. The best term depends on your needs, financial circumstances and capacity to repay the loan. It should allow you to make on-time monthly payments within your budget while helping you pay off the loan as quickly as possible.
Long-Term Car Loans
Car loans with payment terms that last longer than 36 months (three years) up to about 84 months (seven years) are considered long. The extended payment period is designed to reduce the monthly repayment, making the loan more affordable.
The rise of long-term car financing is attributed to the growing number of car buyers favouring costlier SUVs. To make these luxury vehicles affordable to many buyers, lenders reduce the monthly repayment by stretching out the term of the loan.
However, the long repayment period also increases the interest paid over the life of the loan. This substantially increases the overall cost of car ownership.
The long term also puts you at greater risk of being upside down on your loan. Also called “underwater” or negative equity, it happens when your current loan balance is higher than the actual value of your car. Remember that a new car depreciates quickly in value. As soon as it is driven off the dealership, it loses about 10% of its value. In about five years, its value plummets 35% further down. If you plan on selling your car after several years, its resale value is much lower than the price that you pay upfront.
- Spread repayments over a long period, making the loan more affordable
- Small monthly payments that fit work with your budget
- Preserves cash flow for investment
- Greater amount of interest paid over time
- High risk of getting underwater on the loan
- Requires a long time to be completed and can take a chuck of the money for other financial goals
Short-Term Car Loans
This car financing has payment terms of 12 months (one year) to 36 months (three years). While you can quickly pay off your loan obligation, the monthly payments are expectedly higher than long-term car loans and may financially weigh heavily on your wallet.
Short-term car loans usually have a lower interest rate than longer-term loans. This is why many borrowers with high credit scores opt for these types of vehicle financing.
If you have bad credit, on the other hand, lenders are likely to offer you car financing with shorter terms but charge you a higher interest rate. This is to compensate for the high risk of granting you the funds.
- Can be completed in a short time
- Low total cost of ownership and interest payments
- Low risk of negative equity
- Large monthly payments that can be difficult to manage
- Eats up a substantial part of your budget
- High risk of late payments and default, especially if your financial situation deteriorates
Your Car Loan Term and the Equated Monthly Instalment
The term of your car loan greatly affects your Equated Monthly Instalment, which is the amount you pay every month until your debt is paid off.
A long-term car loan can keep your EMI low but you’d pay more in interest over time. Meanwhile, short-term financing can pay off your debt in a short period and help you save more in interest charges but you will have to pay a larger EMI.
To get an estimate of how much regular repayments you’d likely make on a car based on your loan amount and its tenure, use a Car Loan Calculator.
Which Car Loan Term Is Best For You?
While reports suggest that long-term car loans are more popular among Aussies as dealerships and lenders try to make luxury cars more accessible to the general public, the ideal car loan term may be different in your situation.
Here are helpful questions to guide your decisions:
1. What car are you buying?
If you want to buy a luxury vehicle that may cost you quite a fortune, a long-term car loan may work best. By stretching out your loan over an extended period, your monthly repayments lessen. This way, you won’t struggle with budgeting and making on-time payments. You will also have more money left for spending or savings.
2. Is the car old or new?
Used cars have higher interest rates because they are harder to value and riskier to finance. In the event of a repossession, lenders may have a hard time to find a buyer and end up losing money. Additionally, they don’t come with better incentives like new cars. Thus, lenders compensate for these risks by charging you a high interest rate.
If you’re purchasing a used car, it may be wise to opt for a short repayment period so you won’t spend a long time paying for the high interest.
3. How much can you afford to pay monthly?
If you can’t afford to provide a substantial amount of money for the weekly, monthly or fortnightly repayments, it may be wiser to get long-term car financing. It will help you make on-time payments, which boosts your credit profile and helps you easily secure financing in the future.
4. Are you planning to sell your car in the future?
It is best to get a short-term car loan if you don’t intend to keep your car for a long time. This will keep you from getting upside down on your loan. You’re also likely to have your car in better condition after completing your loan, allowing you to sell it at a better price. Aside from car depreciation, old cars have lower mileage and more wear and tear.
5. What is your financial situation?
If you’re relying on your average employment income to pay off your loan, it's wise to request a long time to pay off your debt. You’ll always have money for the monthly repayment but it won’t take a big chunk out of your monthly budget.
On the other hand, if you can provide a substantial downpayment for your loan, have a profitable business and a good credit score that allows you to get financing at low interest rates, go for a short-term car loan. You can settle off your debts early while paying less interest during the life of the loan.
6. Do you have other financial goals to work on?
If you’re planning to buy a house or start a new business after completing your car loan obligation, make the repayment period short so you can move on to your next financial goal fast.
Short-term or long-term, the best car loan term depends on your financial circumstances and goals. Choose one that allows you to make on-time payments without running out your budget, as well as helps improve your creditworthiness.
Positive Lending Solutions is a financing broker that serves Aussies nationwide. We provide fast and efficient loan solutions to the once slow and complicated process of vehicle finance, as well as personal loans for boats, motorbikes, caravans and jet skis. Call us on 1300 722 210 or get a 60-second Quick Quote now!