Is 7 Years Too Long to Finance a Car?

How much is too much?

The old 20%2220/4/10%20rule 20%2220 of car buying stipulates that you should have a down payment of 20%2020, have a loan that is no more than four years, and have a monthly total car budget that does not exceed 10% of your take-home pay. But in actuality, this rule is out of date and disregarded given how costly new and used cars are these days. This is why Edmunds recommends a 60-month auto loan if you can manage it. Although the monthly payment on a longer loan might be more manageable, there are a number of disadvantages that we will cover later.

The trend is actually worse for used car loans. In 2023, the mean duration of a used car loan was 70 months, as opposed to 67 months in 2019. The most common loan term for a used car in the first quarter of 2022 was 72 months. Even though people finance used cars for around $10,000 less than they do new cars, the loan repayment period for both types of cars is about the same.

“Consumers are battling two things,” said Melinda Zabritski, senior director, solutions consulting at Experian. They are trying to get a good interest rate and a reasonable monthly payment. However, Zabritski noted that a five-year loan frequently has a monthly payment that is too high for them, so they wind up financing for a longer term even though it will cost them more in the long run.

A six- or seven-year auto loan has a lower monthly payment, but is there any other benefit? In fact, there are many reasons why you shouldnt choose a long car loan. Lets take a closer look.

This is something that many people dont consider before taking out a long loan. When our cars are brand-new, we adore them, but as soon as the novelty wears off, we can’t wait to trade them in for something new.

Americans typically own new cars for eight years, but because used cars are older, people tend to own them for shorter periods of time. Despite the post-COVID inventory crunch, inflation, and higher interest rates, the allure of a “new car smell” is still strong.

Lets take those average lengths of ownership and see what happens with various loan terms.

First, new cars: Let’s say you have a 72-month auto loan and, around the typical 100-month mark, you start to feel the need to purchase a new vehicle. You are only getting two years and four months without a car payment. Should you opt for an extended 84-month loan and become dissatisfied with your vehicle within five or six years, you would be obliged to make payments for an entire year on a vehicle you were eager to sell. Another option, if you were really desperate to get rid of the car, would be to roll over the remaining loan months into your next car purchase. Edmunds data shows that some people may be doing just that.

The average age of a car when its traded in for a new one is 5. 5 years. However, in November 2023, to give a recent example, roughly 2055 percent of the cars traded in were less than 2055 years old. According to Ivan Drury, Edmunds director of insights, this includes a spike in trade-ins at about the two-year mark, indicating a shift in an earlier spike that used to occur at about three years. Almost always, this type of trade-in is a bad idea because it results in a longer loan commitment and higher monthly payments for the subsequent vehicle.

Let’s now examine used cars. Suppose, as most people do, that you purchase a three-year-old used car and finance it over a 72-month term. You will only have enjoyed a year without auto payments if, after about seven years, you grow tired of the vehicle. If you choose to keep it, youre faced with a vehicle that is 9 to 10 years old.

“Thats risky business when you consider wear-and-tear,” Drury says. “You could be at greater risk of rolling the negative equity into your next car loan. “.

Contrast these situations with buyers who choose five-year loans. They have been free of auto payments for just over three years at the average ownership point of 100 months, and they are free to sell the car anytime they choose.

Higher interest rates are another reason to stick with a 60-month loan. You will pay more interest on the loan over its longer term in terms of both the interest rate and the finance charges over time.

As of right now in 2023, the typical loan amount for a new car is approximately $40,000, with an average interest rate of 7. 2% and an average term of 69 months. That amounted to an average monthly payment of $734, which is a substantial amount of money for most households. Its easy to see why someone would opt for a longer loan. Total interest paid over the life of loan? Almost $9,000.

Contrast that with an 84-month auto loan. The interest rate would be higher, which is common for longer loans. According to Edmunds data, the rate is averaging about 9. 4% near the end of 2023. The monthly payment for an 84-month loan for our new car, with a $40,000 loan amount, would be approximately $650. Still a significant chunk, but less than the shorter loan. However, extending the loan results in an astounding $5,800 in additional costs over its lifetime, which equates to nearly nine additional monthly payments.

It takes longer to accumulate equity in a car due to the longer loan terms and the additional time required for payments. The faster you get to equity, the more flexibility you have to sell it or trade it in.

A new car typically depreciates 15% to 20% in its first year. You typically have “negative equity” in a car at the start of a loan because you owe more on it than it is worth because of that depreciation. This situation is also known as being “upside down” or “underwater. ” If you make a down payment thats too small, you put yourself further underwater. And you go deeper still if you opt for a longer loan term. The additional finance charges are to blame.

The car you purchased and your down payment will determine how long it takes you to accrue equity in it. And equity is what you want: It gives you choices. If your other debts pile up or you lose your job, you can sell the car if you have equity in it. Negative equity, on the other hand, limits your options if youre in a money bind. It also ties you down if you get tired of your car before its paid off. A buyer will only pay you what the car is worth, not what you owe on it. Youre stuck with the balance of the loan.

In a similar vein, your insurance provider will only reimburse you for the car’s market value at the time of the accident if you are in an accident and it is totaled. If you don’t have gap insurance or new car replacement insurance, you’ll have to pay the remaining balance yourself.

Resale value is another reason to steer clear of extra-long car loans. When it comes time to sell your car after you’ve paid it off, a five-year-old car is worth more in the used car market than a seven-year-old one. A 5-year-old car has lost about 48% of its value when new. A 7-year-old car has depreciated by about 59%. Put another way, the $40,000 new vehicle in our example will be worth roughly $20,800 after five years. It drops to $16,400 at the seven-year mark.

A dealership will always give you more money for the 5-year-old car. That age still makes it a strong contender for certified pre-owned (CPO) status, which entitles the dealer to a higher-valued vehicle for sale.

On the other hand, a 7-year-old car is no longer a CPO candidate. Most automakers wont consider a car thats more than 5 years old. Likewise, if it has too many miles, it wont qualify for a CPO program. That means you will get far less for the car as a trade-in.

Is a 72- or 84-month car loan a bad idea?

• authored by Senior Consumer Advice Editor Ronald Montoya Over his career, he has bought and sold over 100 cars in addition to writing over a thousand articles about cars. Ronald has contributed to the Associated Press and works as a senior consumer advice editor and content strategist at Edmunds. He has also discussed a variety of auto-related subjects on ABC, NBC, and NPR. He began his career in the automotive industry by accepting a part-time position in the accounting and service departments of a car dealership.
• Share:

Although the post-pandemic inventory of new cars has mostly stabilized, buyers’ financing costs are still exceeding the maximum amount possible. The average new car payment, through November 2023, has risen to $734, according to Edmunds data. That represents a rise of roughly 2013% since our previous report on this data from the first quarter of 202022.

The increase is a result of both growing interest rates and a trend in which consumers are choosing more expensive trucks and SUVs. Rates have steadily climbed from 4. 4% in February 2022 to 7. 4% in November 2023.

Another factor driving higher monthly car payments: shorter car loans. While shorter-term loans have more than doubled since 2019, the majority of new car loans are about 2064 percent of those financed through a dealer, with a duration of 2067–24 months. Loans of 48 months or less increased from just under 7% in 2019 to slightly over 14% today.

Rates are generally lower for shorter terms, and buyers usually finance less (roughly $30,000) for shorter terms. However, even with rates of roughly 4%, the average payment for loans lasting between 31 and 48 months is roughly $775, with an E2%80%94 percentage that is not much less than the overall increase observed in 202023.

Is 7 years too long for a car loan?