The Pros and Cons of Short-Term Car Loans
Short-term car loans can be a smart way to reduce the total amount you end up paying for your car, but they come with the downside of higher monthly payments.
Our recommendation: Opt for the shortest car loan term you can afford to keep costs as low as possible.
- Pros of short-term auto loans
- Cons of short-term auto loans
- Refinancing to a shorter auto loan
- Alternatives to short-term auto loans
Of course, “short” is in the eye of the beholder. A short auto loan length may be 36 months to one borrower, and 12 months to another. A 60-month car loan was long considered conventional, but the average new-car buyer is creeping closer to 70 months. Some banks and credit unions even offer 96-month terms.
Pros of short-term car loans
In general, the shorter the loan term, the less you’ll pay overall for the car. You also reduce your chances of owing more than the car is worth.
Long-term car loans are tempting, but the math is a compelling reason to avoid them. Here’s a comparison of monthly payments, finance charges and total payments across a range of common loan terms for a borrower with fair-to-good credit. Taxes and title and license fees will depend on your local or state government’s rules.
|Taxes @ 8.6%||$3,350||$3,350||$3,350||$3,350||$3,350|
|Title & License fees||$50||$50||$50||$50||$50|
|Down payment (10%)||4,325||4,325||4,325||4,325||4,325|
|Finance (interest) charge||$1,680||$4,909||$6,584||$8,301||$10,057|
|Total of payments||$39,703||$42,931||$44,607||$46,323||$48,080|
In this example, adding 12 months to the term means you would pay about $1,700 more in interest. Use one of our auto loan calculators to try out different terms for your car loan.
Lower interest rate
It’s likely you’ll be able to get a lower APR on a 36-month loan compared to a longer-term deal.
Build equity faster
The faster you pay down the loan, the less likely you are to owe more than the car is worth. This is important if you think you might trade in or sell your car before the loan is paid off. With a short-term car loan, you build equity faster and are less likely to wind up with negative equity — what’s known as becoming “upside down” on your loan.
Save on insurance
Once you own the car, you can have choices on how much insurance you have to carry on the car. A lender will usually require damage coverage on the car to protect its value in case of an accident. Once the loan is paid off, you could only carry the insurance required in your state. You could also drop GAP insurance if you had it, which would pay the difference between the car’s value and the loan balance in case the car is totaled.
Use the savings for other things
After you pay off your short-term car loan, you can use the money for something else, like savings, investment or anything else you may need.
Once the car loan is paid off, you have the freedom to trade it in or sell the vehicle and receive the full value from it. Or, you can drive it for miles and miles, satisfied that you spent as little as possible.
Cons of short-term car loans
While short-term car loans may make sense on paper, it may not fit into the realities of your monthly budget.
Higher monthly payments
There’s no doubt that shortening the loan term will reduce the amount of interest you pay on the loan, bringing down the overall cost of your new car. But paying that finance fee in a condensed amount of time also raises your monthly payment, and you may not have the monthly cash flow to make that payment. That’s why the car salesperson often concentrates on the monthly payment while selling you a car — they don’t want you to think about the total cost.
Buy a cheaper car instead
If your budget can’t handle a higher payment, it may be a sign to look for a less expensive car. You could opt for a cheaper new car or shop for a used car that will be a better fit for your monthly obligations.
Hard to find a short-term loan
The trend is toward long-term loans, so it’s becoming more difficult to find a new car loan for 12 or 24 months. Still, there are some banks and credit unions that do offer terms at those lengths.
Refinancing to a shorter auto loan
If you already have an auto loan and want to shorten the term, you can refinance the loan. You could pick a short-term car loan compared to what you have now. Keep in mind lenders may have mileage and/or age restrictions on the cars they will finance.
Like financing a car for the first time, refinancing to a shorter term may also mean a higher monthly payment, unless you are able to obtain a lower interest rate.
Here are some cases where refinancing makes sense:
- Your income changes
- Your credit score improves
- Interest rates drop
- You want a different loan term
Alternatives to short-term car loans
If you like the idea of paying as little interest as possible but can’t afford the higher monthly payment, there are some alternatives.
Make a larger down payment
You can pay more money upfront to reduce the amount of money you have to borrow. The lower loan balance could mean you could also afford a short-term financing deal.
Buy a car with a longer loan, say 60 or 72 months, but make larger payments like it’s a 36-month loan. Known as paying down the principal of your loan, you’ll pay the car off faster. If for some reason you can’t make the extra payment in a given month, you can always opt to pay just the normal amount. Check to see if your loan has a prepayment penalty.
Whether you’re buying a new or used vehicle, or refinancing the vehicle you already have, shop around for short-term car loans to compare payments.
It doesn’t hurt your credit to apply to multiple lenders any more than it does to apply to one if you do all your applications within 14 days — and some credit scoring methods may even allow you up to 45 days.
Fill out an online form at LendingTree and get up to five potential auto loan offers from lenders, depending on your creditworthiness. You can also work directly with banks, credit unions and online lenders.