"Consumers are battling two things," said Melinda Zabritski, senior director, automotive financial solutions at Experian. They are trying to get a good interest rate and a reasonable monthly payment. But a five-year loan often has a monthly payment that is too high for them, and they end up financing for a longer term even if it costs them more down the line, Zabritski said.
Is there any benefit to having a six- or seven-year car loan aside from a lower monthly payment? No. In fact, there are many reasons why you shouldn't choose a long car loan. Let's take a closer look.
This is something that many people don't consider before taking out a long loan. We love our cars when they are brand-new, but when the romance fades, we're eager to trade them in for something else.
The average length of ownership for a new car is about 8.4 years (100.8 months), according to Wards Auto. Used car ownership should be shorter, given that the vehicle is older, so let's estimate about a year and a half less, or 7 years. Americans do not tend to drive their cars "until the wheels fall off," no matter what they say they're going to do when they buy them.
Let's take those average lengths of ownership and see what happens with various loan terms.
First, new cars: Imagine you have a 72-month auto loan and you get the itch to buy a new car right about at that common 100-month mark. You are only getting two years and four months without a car payment.
If you took out an 84-month loan and you grew tired of your car in six years, you'd be stuck with a year's worth of payments for a car you couldn't wait to unload. If you were really desperate to dump the car, an alternative would be to roll the remaining months of the loan into your next car purchase. But that's almost always a bad idea because it creates a longer loan commitment and higher monthly payments for the next car.
Now let's look at used cars: Say you buy a 3-year-old used car and pay for it with a 72-month loan, as most people do. And if you're like most people, you'll be tired of the car after about seven years. You will have only enjoyed a year without car payments. And if you choose to keep it, you're now faced with a vehicle that is nine to ten years old.
"That's risky business when you consider wear-and-tear," said Ivan Drury, Edmunds' senior manager of insights. "You could be at greater risk of rolling the negative equity into your next car loan."
Contrast these situations with buyers who've chosen five-year loans. At the average ownership mark of 100 months, they have already enjoyed just over three years without car payments and have the freedom to sell the car whenever they want.
Higher interest costs
Higher interest rates are another reason to stick with a 60-month loan. The longer the term, the more interest you will pay on the loan, both in terms of the rate itself and the finance charges over time. Here's how the numbers look when you compare a 60-month loan to a 72-month loan.
The average loan amount for a new car in the first quarter of 2022 was $39,340, with an average interest rate of 5.2% for a 60-month loan. The finance charges over the life of the loan would be $5,420, giving you a monthly payment of $746, which is a considerable chunk of money. It's easy to see why someone would opt for a longer loan.
Contrast that with a 72-month auto loan. The interest rate would be higher, which is common for longer loans. According to Edmunds data, the rate is averaging about 5.4% in early 2022.
For our new car with a loan amount of $39,340, the monthly payment for the 72-month loan would be about $641, including finance charges of $6,804 over the life of the loan. You can see how someone would feel comfortable taking on the longer loan in favor of the lower payments.
But let's say this person needed to bring the monthly payment down even more and took out an 84-month loan. The monthly payment would be about $563. It seems like a big improvement over 60 months until you see the finance charges: $7,990 over the life of the loan. That's $2,570 more over the life of the loan, yet 34% of new-car buyers are willing to make that compromise.
If you purchased a used car with a 72-month loan term at the average financed price of $30,830, your monthly payment would be $559. It seems like a win from a monthly payment perspective. However, interest rates are much higher for used cars, and a rate of 9.2% is fairly common. You'd be paying $9,403 in finance charges — $2,600 more than a new car loan with the same term.
The extra years spent making payments on longer loans means it also takes longer to build equity in the car. The faster you get to equity, the more flexibility you have to sell it or trade it in.