Should You Choose a Short-Term or Long-Term Auto Loan? Here’s What to Know
When you’re considering financing the purchase of a vehicle, one of the biggest decisions you’ll face is choosing between a short-term or long-term auto loan. Both options come with distinct advantages and disadvantages, and the right choice for you depends on your financial situation, goals, and personal preferences.
In this article, we’ll explore the differences between short-term and long-term auto loans, including their benefits and drawbacks. By the end of this article, you’ll have a better understanding of which loan term might be the best fit for your circumstances.
What is a Short-Term Auto Loan?
A short-term auto loan typically refers to a loan with a term of 36 months (3 years) or less. The exact length of the loan will vary depending on the lender, but loans of 24 or 36 months are common. This type of loan is often associated with larger monthly payments and a faster payoff.
Key Features of Short-Term Auto Loans:
- Loan Term: 24 to 36 months, sometimes 48 months.
- Monthly Payments: Higher than long-term loans, but paid off more quickly.
- Interest Rates: Usually lower than long-term loans due to the shorter repayment period.
- Total Interest Paid: Less total interest paid over the life of the loan.
Advantages of Short-Term Auto Loans:
- Lower Interest Rates
One of the biggest benefits of short-term auto loans is that they typically come with lower interest rates than long-term loans. Lenders see short-term loans as less risky because the repayment period is shorter, so you’re less likely to default. This results in a lower interest rate, which can save you money over the life of the loan. - Less Interest Paid Over Time
Because you’re repaying the loan over a shorter period, you’ll end up paying less in interest over the life of the loan compared to a longer-term loan. For instance, if you take out a loan with a higher interest rate but pay it off in a shorter time frame, the amount of interest you pay will be less in total. - Faster Debt Repayment
Short-term auto loans allow you to pay off your car loan faster. Once the loan is paid off, you own the vehicle outright, giving you the freedom to save for your next purchase or make other financial decisions without a car payment hanging over your head. - Build Equity Faster
Because you’re paying down the loan principal at a faster pace, you build equity in the vehicle more quickly. This is particularly helpful if you plan to trade in or sell the car before the loan is paid off. It reduces the likelihood of being upside-down on the loan (owing more than the car is worth).
Disadvantages of Short-Term Auto Loans:
- Higher Monthly Payments
The most significant drawback of a short-term auto loan is the higher monthly payments. With a shorter loan term, you’re paying off the vehicle more quickly, which means your monthly payments are larger. While this can be manageable for some, it might be difficult for others, especially if you’re on a tight budget. - Less Flexibility in Your Budget
Higher monthly payments can strain your budget, leaving less room for other expenses or savings. If an emergency arises or your financial situation changes, it might be harder to adjust with a higher car payment in the mix. - Potential for Affordability Issues
Because the monthly payments are higher, you may be limited in the type of vehicle you can afford. If your budget is tight, you may have to settle for a less expensive car or take on a larger down payment to keep the monthly payments manageable.
What is a Long-Term Auto Loan?
A long-term auto loan generally refers to loans with terms of 60 months (5 years) or more, with many borrowers opting for 72-month (6 years) or even 84-month (7 years) loans. While the monthly payments are lower compared to short-term loans, the total amount you’ll pay over the life of the loan is generally higher.
Key Features of Long-Term Auto Loans:
- Loan Term: Typically 60 to 84 months.
- Monthly Payments: Lower than short-term loans but stretched over a longer period.
- Interest Rates: Typically higher than short-term loans, as they’re considered riskier for lenders.
- Total Interest Paid: More total interest paid over the life of the loan.
Advantages of Long-Term Auto Loans:
- Lower Monthly Payments
The most obvious benefit of long-term auto loans is the lower monthly payments. Spreading the loan amount over a longer period reduces the amount you need to pay each month. This can be a more affordable option for buyers who need to keep their monthly expenses low. - More Affordable Car Options
Because the monthly payments are lower, you may be able to afford a more expensive car than you would with a short-term loan. If you need a larger vehicle, like an SUV or truck, or if you’re considering a higher-end car, a long-term loan could make these options more attainable. - More Financial Flexibility
With lower monthly payments, you have more flexibility in your budget. This can allow you to allocate more money toward other financial goals, such as saving for retirement, paying off credit card debt, or building an emergency fund. - Potential for Lower Initial Payments
If you’re in a situation where you’re trying to make a large purchase and manage other financial commitments at the same time, a long-term loan allows you to make smaller initial payments, which can ease your budget as you adjust to the new loan.
Disadvantages of Long-Term Auto Loans:
- Higher Interest Rates
While the lower monthly payments may seem appealing, long-term auto loans typically come with higher interest rates. Lenders consider longer repayment terms to be riskier, so they compensate by charging more in interest. Over time, this can add up and increase the total cost of the loan. - More Interest Paid Over Time
Longer loan terms mean that you’ll be paying interest for a longer period. Even though the monthly payments are lower, you’ll pay much more in interest compared to a short-term loan. For example, a 72-month loan on a $30,000 car at 6% interest will cost significantly more in interest than a 36-month loan with the same interest rate. - Slower Equity Buildup
Because you’re paying off a smaller portion of the principal each month, it will take longer to build equity in the vehicle. This means that if you want to sell or trade the car before the loan is paid off, you may owe more on the loan than the car is worth—also known as being “upside-down” on your loan. - Risk of Negative Equity
With a longer loan term, there’s a higher likelihood that your car will depreciate faster than you pay down the loan. As a result, you may find yourself owing more than the car is worth if you need to sell or trade it in before the loan is paid off.
Short-Term vs. Long-Term Auto Loans: Which Is Right for You?
The decision between a short-term and long-term auto loan depends on several factors, including your financial situation, goals, and preferences. Let’s break down when one option might be better than the other:
When a Short-Term Loan Is a Good Option:
- You Want to Save Money on Interest: If you can afford higher monthly payments and want to minimize the total cost of the car, a short-term loan may be the best option.
- You Can Afford Higher Payments: If you have a stable income and can comfortably handle higher monthly payments, choosing a short-term loan allows you to pay off the car faster and build equity more quickly.
- You Want to Own the Car Faster: If you want to own your vehicle outright and without a car payment as soon as possible, a short-term loan is the best option for faster debt repayment.
When a Long-Term Loan Is a Good Option:
- You Need Lower Monthly Payments: If you’re on a tight budget and need to keep your monthly car payment low, a long-term loan can provide you with more flexibility in your finances.
- You Want to Afford a More Expensive Vehicle: If you need a higher-priced car or want more features, a long-term loan can help you afford a more expensive vehicle while keeping monthly payments manageable.
- You Want More Financial Flexibility: If you have other financial priorities or want to ensure that you have room in your budget for emergencies or other obligations, a long-term loan can give you the breathing room you need.
Conclusion
Choosing between a short-term or long-term auto loan depends on your priorities—whether that’s saving money on interest, having lower monthly payments, or paying off the loan faster. A short-term loan is ideal if you can afford higher payments and want to minimize the total cost of your car, while a long-term loan may be better if you need to reduce your monthly payment for greater flexibility or if you’re purchasing a more expensive vehicle.
Ultimately, the right choice comes down to your financial goals and what you’re most comfortable with. By carefully considering your budget, the total cost of the loan, and how long you want to be paying for the car, you’ll be able to choose the loan term that works best for your needs.