Here’s how long a car should be financed new or used

Steer clear of financial potholes when you buy a car.

That might be easier said than done if you already have your eye on a shiny new vehicle. But you could pay a price if you don’t know how long a car should be financed.

The average price of a new vehicle has climbed to around $48,000, a stretch for many shoppers, while SUVs and trucks – which are attracting much of the current buyer interest – generally cost even more. Used vehicles, too, have climbed to an average price of around $28,000.

Shoppers are borrowing an average of more than $39,000 for a new vehicle and about $27,000 for a preowned vehicle, based on data from Experian, Edmunds, LendingTree and other sources.

But if you need to finance a vehicle for six or seven years (72 to 84 months) or more, there’s a good chance it may be beyond your budget, based on research by the Consumer Financial Protection Bureau (CFPB), even though vehicles generally are lasting longer than ever before.

What’s more, the average length of a finance contract has reached 70 months for a new car and 67 months for a used car, according to a report by LendingTree. That means a lot of buyers may be in the same boat, borrowing more money than they can afford.

Three signs of trouble

Here are some signals to consider when figuring out how long a car should be financed:
1. Longer-term financing often is related closely to the credit score of the borrower, with those least able to cover the additional costs – borrowers with lower credit scores – more likely to borrow for six years or longer, according to the CFPB.
2. Longer-term financing also is related to the dollar amount borrowed, which again may signal a vehicle purchase that exceeds the borrower’s ability to repay, the CFPB reports.
3. Default rates for longer-term borrowing are higher than those for shorter-term contracts, despite the apparently lower financial burden to make each month’s payments.

More-affordable financing?

“While longer loan terms may make payments more affordable, it is not clear consumers are better off … or that they will be more likely to repay the loan,” said the CFPB. “Longer-term loans amortize more slowly and, as a result, financing costs will be higher over the life of the loan.”

While borrowers generally may intend to make their monthly payments, the CFPB’s report shows that certain financial basics should provide cautionary signals.

Generally speaking, the longer you finance, the more interest you will have to pay. Many experts recommend a five-year loan or less if you can make it work. While a longer term might get you a lower monthly payment, your cost to own the vehicle will likely be higher based on interest paid over a longer length of time.

Typical timelines

With that updated design and latest technology, it’s no surprise we love our vehicles when they’re brand-new, or new to you. But as the years — and miles — go by, that love can fade and lead to thoughts of trading them in. Consider the scenario of taking out a six-year loan on a three-year-old car. At the end of that car loan term, you’ve got a nine-year-old automobile that you’re eager to replace.

If you find yourself wanting a new vehicle before your loan term is up, this could lead to negative equity on your next car loan as well. Here’s the thing, trading in your vehicle when you’re already upside-down could mean that the difference between what you owe and what your vehicle is worth ultimately gets added to your new vehicle loan. This practice puts you behind on your new vehicle before you even drive off the lot.

Upside down or right-side up?

In its first year, a new car typically depreciates about 25 percent. At the beginning of a loan, the buyer is usually “upside-down,” or “underwater,” meaning you owe more than the vehicle is worth. As mentioned previously, the longer the loan term, the more you’ll likely have to pay in finance charges. The situation is made worse if you weren’t in a position to make a large enough down payment. Or if you’ve rolled negative equity from your previous vehicle into this one.

However, if you’re able to pay off that longer term loan, you’ll have an automobile you don’t owe anything on. A great place to be! You could keep driving it and enjoy life without a car payment, or you might want to trade it in for something new.

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The bottom line

So, how long should a car be financed? The answer lies in your personal situation. For many car shoppers, paying cash isn’t an option, so it’s a choice among multiple loan terms available and what works best for you.

There are also calculators, including affordability and budget, that can help you work through different scenarios before you finance a vehicle. The more you know, the happier you’ll be with your vehicle financing and decision you make on your next ride.

These statements are informational suggestions only and should not be construed as legal, accounting or professional advice, nor are they intended as a substitute for legal or professional guidance.

Santander Consumer USA is not a credit counseling service and makes no representations about the responsible use of or restoration of consumer credit.

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