Is Your Car Loan Term Too Long?

Car Loan Payments and TermWith the reduction in affordable car leases, many people have turned to car loans to finance their new or used car purchase. Unfortunately the trend has been for Canadians to extend the term of these loans to reduce the monthly car loan payment so it fits within the family budget. J.D. Powers & Associates recently reported that 63% of new car loans in 2013 were for a term of six years or longer. It is now not unusual to see car loans extending to as long as eight years or 96 months.

But does this make sense? While reducing your monthly debt repayment may help manage your monthly cash flow, you may never see the value from your total debt payments.  Let’s look at an example.

Let’s assume you have the choice of two cars and rather than lease you have negotiated a great up front cash price.

Car A Car B
Purchase Price $26,500 $36,800
Interest Rate 5.8% 5.8%
Loan Term 4 year (48 months) 7 years (84 months)
Loan Payment $620.02 $534.16

Looking at this simple table it appears that you can afford that bigger car because the monthly debt payments are less. But let’s take this simple story one step further. How much will each of these cars cost in the long run?

Car A Car B
Purchase Price $26,500 $36,800
Interest Payments $3,256 $8,061
Total Payments $29,756 $44,861

While your monthly debt payments on Car B might be less, you will pay $4,805 more in interest if you purchase Car B and extend the term. That is almost one fifth the price of Car A!

So before you extend the term of your car loan ask yourself, are you doing so to afford more car than you need? What will the car be worth when you do finally pay off that long term car loan? Will you be able to replace it given all the extra you have been paying in debt payments over the years?

One last thing. Do you notice how I keep call them debt payments and not loan payments. That’s because when you consider taking on a long term loan you really need to keep in mind that you will be ‘in debt’ for that long. Things can change over that period of time. You could lose your job, become ill or have other financial emergencies.

So how long is too long for a car loan? Only you can decide but you need to think beyond the monthly payment.

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