The length of your car loan affects your finances in a few ways. Shorter terms get lower rates so you pay less total interest and you'll be debt-free faster. But longer loan terms give you a more affordable monthly payment.
So how long should a car loan be? While there's no single answer, you want to choose the shortest loan term possible to keep your cost of borrowing down. Shorter terms also mean you're less likely to end up with negative equity.
Read on to find out how to choose the ideal length for your car loan!
What Is the Average Car Loan Length?
The average length of an auto loan for a new car rose to 70.4 months in the first quarter of 2022. But just because a loan term of 72 months is common doesn't mean it's the best option.
In recent years, high prices for new and used vehicles are forcing people to take out larger loans than spread the amount over a longer period so it's affordable.
The 20/4/10 Auto Financing Rule
In the past, people referred to the 20/4/10 rule when answering the question, “How long should a car loan be?” The rule says you should:
Make a 20% down payment
Have a loan term no longer than four years or 48 months
Have a total monthly car budget of about 10% of your take-home pay
But current trends suggest many people can't afford a large down payment or the monthly payment that comes with a short loan term. That's why you should try to find a middle ground that works for your situation.
How to Choose the Best Car Loan Term for Your Needs
There are many important things you should consider before deciding how long you'll finance your new car. Most importantly, you want to be able to afford the payments over your entire loan term so you're not at risk of losing your car.
Budget for Your Monthly Payment
Before you go shopping for your dream car, take the time to work out a monthly budget.
Add up all your income and subtract all your expenses.
See how much room you have left for a potential car payment.
Find a loan term that gives you a car payment of around 10% of your take-home pay.
The price of your chosen vehicle will impact how much you need to borrow, your monthly payment, and your total cost of borrowing (including interest and fees). You can use a Vehicle Affordability Calculator to see the ideal price range that will give you an affordable car payment.
Many people can only afford to buy a high-value car if they opt for the longest loan term possible. But this means you'll pay significantly more interest than if you chose a less expensive vehicle and/or a shorter loan term. Aim to find a car you can truly afford over a shorter term.
Interest Rate and Total Interest
The annual percentage rate (APR) you're offered is based on a range of factors including your credit score, the age of the vehicle you want to buy, and your preferred loan term.
Shorter loan terms and newer vehicles get the lowest rates.
Longer loan terms and older vehicles get higher rates because they're considered riskier.
Depending on your lender, rates tend to jump when loan terms go over 60 months.
Use your auto loan calculator to see the shortest loan term you can afford.
Remember to look at the monthly payment as well as total interest costs.
If possible, make a higher down payment or buy a less expensive car so you can afford a shorter loan length and save on interest.
New vs. Used Vehicles
On average, people own a car for 8.4 years. So ask yourself if you want to have an auto loan for most of that time, or if your goal is to own your car outright sooner.
Newer vehicles cost more to buy but get lower rates.
They will likely need fewer repairs so you may allow slightly more for your car payment.
Though new cars rapidly depreciate, you should still be able to get a good resale price when you want to sell or trade-in in a few years.
A longer loan term may be okay for newer vehicles, as long as you don't mind paying the extra interest.
Used cars may cost less to buy but you'll get a slightly higher rate.
You'll likely face more maintenance costs on top of your car payment, as well as any trade-in extras like an extended warranty.
Depreciation means your car may not be worth much by the time you sell or trade it in.
Over a long loan term, you may end up owing more on your car than it's worth.
A shorter loan term may be less risky for used vehicles.
Risks of Long Loan Terms
Negative equity is when you owe more on your auto loan than the car is worth, which is called being underwater or upside down on your loan. Here's why that's a problem:
When it comes time to sell your car, you'll need to make up the difference between what you received and what you owe on your loan.
Another option is to roll the missing amount into your next auto loan, but that puts you at risk of quickly going underwater on your new loan, too.
You're more likely to end up underwater on your loan if you finance a used vehicle over a very long loan term (72 to 84 months).
Over that very long period, you'll also face increased maintenance costs and you'll pay high amounts of total interest.
Another downside of negative equity is that you have no asset or positive equity to cash in if you're ever short on money.
Here's the bottom line on your question, “How long should a car loan be?” If you can't afford the monthly payment of the old ideal 48-month term, aim for a loan of about 60 months (five years) instead of 72 months (six years) or longer.
Next Steps: Choosing an Affordable Car Loan
When it comes time to choose a lender for your car loan, make sure there’s a healthy range of loan terms to choose from. Get your finances in order so you might qualify for the best rate possible, choose a vehicle within your affordable price range, and save up for a down payment.
If you do all these things, you'll be sure to have a great car buying experience with a hassle-free auto loan. One more thing, check out your local credit union and compare the rates and terms with other financial institutions. You'll soon see who comes out on top!