With the recent rise in new and used car prices, I receive a lot of questions asking me if it's okay to extend out a car loan term out to 72 months or more. Normally, the only reason someone would want to extend out a loan term is so they can purchase more vehicle or make the monthly payment more affordable.
If you have credit issues or no credit at all, I highly recommend you stay with a 48 month auto loan term or less. You can go with a 54 month or 60 month term, but if you're in a bad credit or no credit situation, I advise you to put more money down and go with the shorter term. The shorter the term, the more money you'll save.
During the fourth quarter of 2014 the average interest rate for a new car loan was 4.5 percent, according to Experian Automotive. However, what most people don't know about this statistic is that it's for people with good to excellent credit (prime borrowers). The difference in interest rate on a 60 or 72 month loan is minimal for these types of car buyers. They may only pay somewhere between $400 to $600 more over the life of the loan, but save anywhere between $50 to $100 a month off their car payment.
Another example of prime borrowers extending their term out to 72 months is to get a lower payment, but still pay more towards the principle every month. If their minimum monthly car payment is $400, they'll pay $450. The extra $50, or whatever the overage is, goes towards the principle. If they're short one month, they only have to come up with the minimum $400. This technique takes discipline, but can save you money in the long run and pay off a vehicle quickly.
You can see where extending a car loan can sometimes actually benefit someone with excellent credit. But how does stretching an auto loan term effect someone with under-average (near-prime borrower) or bad credit (sub-prime borrower).
In the fourth quarter of 2014 the average new car transaction price was $28,381. Even if a credit-challenged person buys a much cheaper vehicle, there's two ways extending the loan term will be more expensive.
1) You agree to buy a new car with a selling price of $17,500, you put down $1,500, and want to finance the remaining $16,000. You're approved for 15.99 percent and finance for 48 months. Your payment will be $453 a month with interest charges of $5,761 over the life of the loan.
In the above example, each additional year you stretch out the loan will add roughly another $1,440 in additional interest charges. If you extend the loan to 60 months, your payment will only be $389 a month, but your interest charges shoot up to $7,340. Looking at extending to 72 months, your payment is $347 a month and your interest charges are $8,983, over half of the amount of the vehicle's selling price.
2) The second way stretching out an auto loan term can hurt you if you're credit-challenged is the longer the vehicle is financed, the longer it will be worth less than what the payoff amount is. What this means is even if you've obtained your goal and reestablished your credit after a couple years. You still will not be able to trade in the vehicle because you still owe way more than what the vehicle is worth (upside down).
If you're unable to come up with cash to make up for the negative equity you may be trapped in your vehicle, paying the higher rate, or risk messing up your credit you just worked so hard on reestablishing.
If you're in a below average, bad credit, or no credit situation and not careful...You could end up paying a lot more in additional interest charges compared to what a prime borrower would pay financing the same vehicle. Review my bad credit auto loan approval guide to learn how to increase your chances of being approved for a bad credit auto loan and also what to expect if you have bad credit.
Visit my Auto Finance Tips Section to read more on how dealers make money financing cars, how your credit report affects your interest rate, common auto finance mistakes, and more.
My advice to car buyers with credit issues BEFORE choosing to extend the term:
If you're considering the purchase of a new vehicle, I recommend using a free online referral service such as CarClearanceDeals and Edmunds to guarantee you pay the lowest price. These services will tell you what others are paying for the vehicle you're considering in your local area and which dealers give the greatest discounts.
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