Short-term vs. Long-term Car Loans: What You Need to Know

Short-Term Car Loans: What You Need to Know

A short-term auto loan may be an appealing option if you’re looking to pay off your next vehicle as quickly as possible. Here’s what you can expect if you’re thinking about a short-term car loan:

• Lower interest rates: Since there’s less risk you’ll default during a shorter loan period—a four-year term compared with a seven-year term, for example—you may be able to score a lower rate. This can help you save on total interest over the length of the loan.
• Higher monthly payments: Short-term car loans generally require higher monthly payments because there’s less time to pay off the loan. Before committing to a shorter loan term, it’s a good idea to check your budget to see if you’re able to swing the payments each month.
• Lower total loan cost: With a short-term loan, you can pay off your car more quickly, which can lower your total overall out-of-pocket costs. And it may help you not overpay for what your vehicle is actually worth.

Long-Term Car Loans: What You Need to Know

With a long-term loan, you’ll have more time to pay off your next vehicle, but you could end up paying more for the car over time. Here’s what you can expect with a long-term auto loan:

• Higher interest rates: Long-term loans can carry more risk for lenders because borrowers may be less able to keep up with payments over time. Lenders compensate for that risk by charging higher rates on long-term loans.
• Lower monthly payments: Stretching out your car loan payments over a longer period of time―four, five or six years, for example—typically translates to lower monthly payments.
• Higher total loan cost: While the lower monthly payments may fit into your budget, you’ll spend more—perhaps thousands of dollars more—for your vehicle than you would if you had a short-term loan.

Is It Better to Have a Short-Term or Long-Term Car Loan?

The lower monthly payments of a long-term loan may be attractive initially, but short-term loans typically cost less over time. To compare options, you can use a car loan calculator.

Let’s take a look at a few different loan terms for a $20,000 loan at an interest rate of 4.75%.

If you opted for the short-term 36-month loan in this case, your payment would be nearly twice what it’d be with a 72-month term, but you’d save more than $1,500 in interest over the life of the loan.

If you can’t swing the monthly payments that come with a short-term loan but want to limit the interest you’ll pay, opting for a 48-month or 60-month loan could be a better fit.

How to Choose the Right Car Loan

From interest rates and terms to your monthly payments, there can be a lot to consider when taking out a loan to buy a car. Let’s take a closer look at some of the steps you’ll want to take as you look at auto financing options.

1. Determine how much you can afford. Make sure that you can fit a car payment into your budget. Consider the monthly loan payments plus the cost of auto insurance, fuel and maintenance.
2. Check your credit scores. The interest rate you’ll qualify for will likely depend heavily on your credit history, so knowing where you stand is important. Before applying, it’s a good idea to check your credit score. The higher your score, the more likely you’ll qualify for lower rates.
3. Shop around for auto loans. From dealer financing to local banks and online lenders, there are many options for vehicle financing. Be sure to compare loan terms, interest rates and other restrictions that may apply, like age of the vehicle.
4. Get preapproved for a car loan. Some lenders may allow you to prequalify for a loan. This can help you get an idea of what your rates and terms may be along with the amount you’d be able to borrow. And it won’t impact your credit score because prequalification requires only a soft inquiry on your credit (unlike when you apply for the loan and the lender does a hard inquiry).
5. Apply for loans in a short window. An official loan application typically results in a hard inquiry on your credit report, which can lower your scores by a few points. But you can lessen the impact on your credit score if you submit your auto loan applications around the same time—typically within 14 to 45 days of one another.