The days of buying a vehicle with cash are long behind us. Car loans and leases are now commonplace. It's feasible to have a 3-5 year car loan, pay it off, then own the car. It's a reasonable timeframe for the average consumer and also ensures that an affordable loan is borrowed. However, problems arise when car loans exceed 5 years.
These days, an increasingly popular method of financing a car is to sign a lengthier term loan, including some that are even 8 years long. In fact, more than half of all car buyers in Canada are taking out loans of 84 months or longer. But while a longer repayment period makes monthly payments smaller for a more expensive car, you may want to reconsider risking your financial health to purchase a depreciating asset.
What are long-term car loans?
Long term car loans are loans that exceed 60-month terms. In other words, loans that are 6 to 8 years in length. The short-term benefit to a longer repayment schedule is it can more easily help you manage the costs of a new car you would otherwise not be able to afford.
When you do this, however, you are taking some big risks:
Overpaying for a car
Smaller monthly payments can be attractive. But, what you may not realize is that by accepting a longer-term loan, you are paying for much more than the value of the car through interest charges.
Let's say for example you buy a car that costs $35,000. The interest rate on your loan is 5%. Your term of the loan is 36 months (3 years). If you borrow for 3 years, you are paying $37,763.33 for the car because you made $2,763.33 in interest payments. Because it's a 3-year loan, your monthly payments on it would be approximately $1,048 a month.
However, if that monthly payment is too high and you opted for a longer repayment period of 72 months instead (6 years) at 5% interest on a loan of $35,000, you would pay more than double in interest charges. Over the 6-year period, the car would cost you $40,584.43 because you made $5,584.43 in interest payments. Your monthly payments on this extended loan, however, would only be $563.67.
While this seems more affordable on the surface, it's actually costing you much more to own that car. Instead, you could purchase a vehicle that falls more within your monthly spending limit, without an extended loan.
In addition to high interest charges, the risk of longer-term car loans is ending up with negative equity. Remember that a car is a depreciating asset. It loses some of its value the moment...