What to Think About When Choosing the Terms on a Car Loan

by Scott Sery on March 11, 2013

Car Loan TermAs many things go in life, it is far better to save money than to take out a loan. For instance, if you want a new TV, new furniture, or other items that are not necessities, do not finance them, and certainly do not use a credit card. This is especially true if you do not have the money currently available to pay it off. Instead, deny yourself that luxury for a little while until you are able to purchase it outright. However, there are some things that it is just not reasonable to save up in order to buy. For instance, without the ability to obtain a mortgage, most people would never own a house. For items such as a car, you can save for them, but during a time of low interest rates it is often more practical to finance than to wait. With all of the loan variables, how do you choose the terms of your loan?

Surprisingly, interest rates will fluctuate in the matter of a day. They are primarily based on the prime rate, and different lenders will always be offering slightly different rates. As the consumer, your rate is based on two things.  Your credit score, a higher score will grant access to lower rates. And the length of the loan, a shorter loan will come with a lower rate.

When choosing your loan, your primary deciding factor will most likely be the amount you can afford each month.  The longer the loan period, the lower your payments will be. At the same time, the longer the loan period, the more you will pay in finance charges. So do you pay more each month, or take the hit to keep your monthly payments low?

Take my case for instance. Last year, our old Honda was on its way out and it was time to upgrade to something newer. Even though we had enough in our savings to buy the car outright, we decided to finance the vehicle rather than deplete our savings. After crunching the numbers, I knew we could afford the payments on a two year loan. Yet, I liked the idea of the lower payment (in case something came up) that the five year loan provided. Since the five year loan only came with about half a percentage point higher interest, we went that route. For the first several months I made quadruple payments. Instead of using the full five years on the loan, the vehicle will be paid off in a total of about 15 months.

So how do you go about choosing?  There are a few simple steps to follow.

  • Go with the financing company that you feel comfortable with in terms of working together. The dealer talked us into using one of their partners, while it ended up working out, I would have liked a little more control.
  • Determine how much you can reasonably afford to pay, and then compare the finance charges between two, three, four, and five year loans. If you have to take a loan with a longer period than five years, you seriously need to consider if you should be buying a car that costs that much.
  • Choosing the exact term is up to you. If you want to make the commitment to take the shorter loan, then do so. If you want to take the longer loan but make extra payments, then you might be more comfortable heading in that direction.

Just remember, if the loan is under 3 percent, you are better off investing your money and making the minimum monthly payments. Inflation is on your side in this instance. But, if you hate debt as much as I do, you will do everything you can to make that five year loan only last a little over a year.

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Scott Sery

Scott Sery is a native to Billings, Montana. Within an hour in nearly any direction he can be found fishing, hunting, backpacking, caving, and rock or ice climbing. With an extensive knowledge of the finance and insurance world, Scott loves to write personal finance articles. When not talking money, he enjoys passing on his knowledge of the back country, or how to live sustainably. You can learn more about Scott on his website Sery Content Development
  • I’ve never had a car loan before but the wife did but it was 0% interest. She invested her money and took the full 5 years to pay off her vehicle. If I had a loan I would pay it off as soon as I could.

    • Late last year I took out a car loan at 1.99%. I invested the money and have already made well more then the total amount of interest that I will pay over the 5 year period.

  • Nick @ ayoungpro.com

    The best terms are no terms….woohoo for cash! 🙂

  • Pingback: The Round Table – March 15, 2013 — MoneySmartGuides.com()

  • I liked your last statement the best. Pay that baby off as fast as you can.

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