It used to be normal to get a car loan for either three years or five years. Or you’d get a thirty-year mortgage—maybe fifteen, if you were really in control of your finances. But now, loan terms seem to be longer than ever before. The average car loan for new vehicles is almost seventy months, and you can actually find mortgages available for forty or even fifty years.
Longer loan terms seem attractive because by stretching out the length of the loan, you can make lower payments each month. But instead of taking the loan term that gives you the lowest payment, you should choose the one that keeps you in debt for the least amount of time you can afford. Doing so allows you to gain equity faster, if you’re paying for an item like a car or house.
It also reduces the amount of interest you pay. Consider a car loan for $20,000 at 5 percent interest. If you pay it off over sixty months (five years), you’ll pay $2,645 in interest. That same loan for eighty-four months (seven years) will cost you $3,745 in interest.
Don’t let a lower monthly payment fool you into paying more interest over time. Do your math before you shop to know how much you can really afford to pay and how quickly you can reasonably do it.