You may not realise it, but the loan term is one of the most important numbers you’ll specify when you’re negotiating your car loan. It can be the difference between thousands of dollars depending on the deal, so it’s very important that you understand how it works and what your term should be. This article will explain.
What Are Loan Terms
If you don;t know, a loan term is the period of time in which you’ll be paying off the car loan, generally negotiated in 12 month increments between 2 and 8 years. meaning : 24, 36, 48, 60, 72, 84, and 96 months are the standard terms negotiated.
In each of these months you’ll be charged part of the car’s value plus a part of the interest gained on the loan. The terms have been calculated so that by the end of the term both the loan and the interest will be paid in full.
Long Terms Vs Short Terms
The most obvious effect of this choice is the monthly payments, the longer your loan term is, the lower those monthly payments will be. However, the part that makes this more complicated is that a longer term also means you’ll end up paying more overall because of interest.
Interest is gained based on the remaining amount of the loan left to pay, so the faster you pay off the loan, the less interest you’ll generate. Meaning from a strictly financial standpoint it makes more sense to take a shorter term loan.
The major flaw of short term loans is the higher monthly payments, while they may be more efficient, that doesn’t make them possible, you may not be able to balance those higher payments into your budget.
The Calculation
Ideally what you need to do is calculate the most efficient term based on your budget and the car you’re trying to purchase. This is mostly going to be based on the monthly payments. You want those monthly payments as big as you can possibly manage without breaking the bank, you don’t want to end up defaulting on the loan.
If you haven’t already, set up a budget to track all your incoming and outgoing expenses. This will give you a clear understanding of what you’re working with. Be careful though, if you’re taking a loan with a variable interest rate then you need to factor fluctuations into your calculation, just because you can afford it now doesn’t mean you can if the interest goes up by 2%.