Longer Payoff Time Decreases Payments but Increases Risk

When you arrive at the car lot to purchase your next car, you will be presented with many options. Traditionally, people would make a down payment on their car, then pay off their car loan within three or four years. Now, people arriving at the dealership are being offered longer loan periods to pay off their car. Five year car loans are becoming more common. Six year automobile loans are not unheard of, and some dealerships are even offering seven and eight year automobile loans! While a longer loan period will lower your payments, it will increase your risk, as well as increase the overall price that you pay for your car (with the additional interest you will pay).

Why Longer Loan Periods are Riskier

Unless you are restoring a classic car, automobiles do not increase in value over time. Your new car will lose value within days of driving it off the lot. If you take out a car loan with a small or no down payment, you will immediately be upside down in your loan. In other words, you will owe more on your car than it is worth. Until the car is worth less than you owe, you are in risky territory. What would happen to your finances if your car was stolen, totaled, or broke down and couldn't be repaired? Your insurance company will typically reimburse you for the value of your car, not for the amount that you owe on your car. You can purchase gap insurance to come up with the gap in the amount that you owe and the amount that your car is worth, but that adds up to extra money.

Another risk that you take when you get an auto loan for a longer time period is that your circumstances may change. Six years from now, you may be living a completely different lifestyle than you do now. Will that beautiful new Ford Mustang fit into your family six years from now, or will you need a larger car to accommodate a larger family? Perhaps your job will send you to another part of the country, where convertibles just don't make sense. By increasing the amount of time that you take to pay off the loan, the chances that you will still want to drive the vehicle by the time you are finished paying for it decrease.

Rolling Over the Upside-Down Portion into a New Loan

Many people think that they can make up for the risk of paying for their car for a longer time-frame by rolling over the amount that they are upside down in their old car into a new automobile loan. They keep their current car for a few years, need a new one, and go to the dealership to buy a new car. If they still owe a few thousand dollars on their old car, they can borrow the difference and roll it into their new loan. This only increases the payment that they will have to make in their new loan, which encourages them to pay for their next car over a longer period of time. This is a vicious cycle that if not broken, could eventually leave you with payments that you cannot keep up with. Before you go out and buy another vehicle, try to make sure that you are not upside down in your current car in order to avoid this trap.

What Loan Payoff Time Frame is Best?

The best loan payoff time frame is the shortest time that is offered that you can comfortably afford the payments. If you can afford the three year loan, don't go for the four or five year loan. Also, try to pay off your car before you purchase your next one. If you like to buy a new car every couple of years, try to get a three year loan. This will reduce your chances of being upside-down in your loan when you have to trade it in. If you are unable to afford the payments with the shorter loan, try to keep your current car for a little while longer while you save up for a larger down payment. Your wallet will thank you in the future.