When shopping for auto loans, many consumers want to secure a low monthly loan rate to make their automobile purchase more budget-friendly. The monthly payment a borrower makes on a car loan is determined by a number of factors, including loan amount, credit risk, and loan term. Additionally, just as cars have become more expensive, they have also become more reliable, and consumers want to get the most out of their vehicle investment by relying on it for several years.1 For these reasons, consumer interest in extended auto loans has risen sharply in recent years. In fact, during the last two years, extended loans (73 to 84 months) have constituted nearly 25% of new car loans.2
Banks have begun to offer longer loan terms to accommodate the desire for a lower monthly payment, extending the amount of time that a borrower has to repay the loan and reducing the monthly payment.
How an 84-month auto loan works
For example, if a borrower applies for a 36-month car loan for $25,000 at a 4.00% annual percentage rate, the monthly payment on the loan will be $738.10. Assuming the same interest rate, if the loan term is extended to 84-months, the monthly payment would be only $341.72.
From the standpoint of a borrower whose primary objective is an affordable monthly payment, the benefit of an 84-month loan is pretty clear. The difference in the payments above is $396.38 - a reduction in the 36-month payment of nearly 54%.
The drawback, of course, is the length of time required to repay the loan and the total cost of the financing for the borrower. A borrower with a 36-month loan would enjoy four fewer years without a car payment compared to a borrower with an 84-month car loan. And if we calculate the total amount paid over the life of the loan ($738.10 x 36 months vs. $341.72 x 84 months), we see that the 84-month borrower is actually paying $2,132.88 more for the same vehicle.
The benefits of long-term loans
- Lower Monthly Payments: With a longer loan, borrowers can enjoy lower monthly payments on a large purchase.
- Loan Qualification: Loan approvals are based primarily on a lender’s assessment on the credit risk associated with an applicant - the risk that a borrower will default on his or her auto loan. Among other factors, lenders determine credit risk by reviewing credit history and debt obligations in relation to monthly income. In the case of a longer-term loan, because the payment is reduced relative to a borrower’s monthly income, borrowers may qualify for a higher loan amount. Other factors include things like previous bankruptcies, previous vehicle loan defaults and the ratio of the loan amount to the vehicle price also play a role in assessing credit risk.
- Higher Financing Costs: As stated above, because interest is paid as a percentage of loan balance each year, adding years to the term of a loan increases the amount of interest paid over the life of the loan. While some find an 84-month loan necessary or convenient, generally speaking, it is usually financially preferable to pay off a loan as quickly as possible.
- Potential Loss with Vehicle Devaluation: Almost immediately after you purchase a vehicle, that vehicle’s value begins to drop. A vehicle’s value will continue to drop over the course of its ownership, with some vehicles devaluing more quickly based on their make, model, use and condition. This is important when it comes to loan terms. If you decide during your loan that you would like a new car, you may experience a financial loss due to the vehicle’s devaluation and the fact that you still owe money on the car. To learn more about vehicle devaluation and the costs involved with car ownership, read our article here.
Auto loans with Nationwide
Nationwide Bank views banking as a partnership, and we want to provide our customers with flexible options that help them balance their monthly obligations. Start the first step to finding your next automobile by getting preapproved for vehicle financing - it takes as little as fifteen minutes!3