Given the average sticker price of a new car, many people are opting to finance cars for as long as possible so that they can afford the monthly payments. Six year terms are becoming more and more common, and even 7-year terms as well, but do they really make sense? Here are a few pros and cons of this type of “long-term” auto financing.
The Pros and Cons of a 6-Year Auto Loan
Being a good news first kind of person, let’s start there. The only good thing about 6-year auto financing is a lower monthly payment. Let’s look at loan for a 2014 Kia Forte Koup EX. According to Kelley Blue Book, the price tag should be $19,740 without applying incentives or any price breaks. If you finance that amount at 6% APR for 6 years, your monthly payment would be $327.14, compared to $463.59 if you financed the same car for 4 years.
That’s a monthly savings of more than $130 for a relatively inexpensive car–a serious chunk of change. However, there are a number of other things to consider, many of which we’ve touched upon previously. The most serious of these is the added interest you’ll pay, but we’ll mention a few others first.
- Credit Score: you may need to have a credit score in excess of 680 in order to qualify for a 6-year term.
- Interest Rate: some lenders are going to add an interest point or two just because the loan is longer. With a 6-year note, you are guaranteed to have negative equity in the vehicle for at least two years, making the loan a bit more risky. That leads right into the next con.
- Negative Equity and Gap Insurance: cars depreciate at an average rate of 15 percent per year for the first 3 years. It slows down after that, but the average four year old car is worth at least 40 percent less than it sold for. That negative equity prompts some lenders to require that borrowers carry gap insurance until they reach a break-even point on their loan. Gap insurance policies can be expensive enough to wipe out the money that you save on monthly payments.
The Big Question: Monthly Savings vs Long-Term Expenses
In the loan described above, you would pay total interest of $3,814.71 during the life of a 72 month loan. On the other hand, you would only pay $2,512.53 in interest if you financed the car for 48 months. Thus, that $130 savings per month ends up costing you about $1300 in the end. Ultimately, this is the trade-off you must consider: are the monthly savings worth the added total expense? If yes, then a loan of this length might be right for you. If no, then a comfortable middle ground may be a 60 month note.
Will You Qualify for a 6-Year Note?
That depends on a wealth of factors, most notably your credit score and income. As mentioned above, you typically need a 680 credit score or higher to qualify, meaning credit that’s at least average, or at the upper end of subprime. You’ll also need a monthly income in excess of $1500 per month, before taxes, and healthy debt-to-income ratio. A down payment is also a big plus, as it lowers the loan-to-value ratio on your loan. The best way to find out if you qualify for such a loan is to submit your application and speak with finance specialist about your options.