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But how long should you finance that new car for? The loan term can significantly impact your overall costs and monthly budget. Let's take a deep dive into auto loan lengths and examine the pros and cons of short vs long loan terms, considering the impact of interest rates on these terms.

The 3 to 5-Year Auto Loan

Historically, the standard auto loan term was 3 to 5 years, or 36 to 60 monthly payments. For many decades, this was the norm that most buyers followed when financing a new vehicle. What is the most significant advantage of a shorter 3-5 year auto loan? You pay less interest charges over the loan life compared to longer terms. The quicker you pay off that principal balance, the less total interest accrues.

Let's look at an example: Say you finance a $30,000 new car at 5% interest for 4 years (48 months). Throughout the loan, you'd pay around $3,300 in interest charges. Not too bad.

Longer Loan Terms Are Getting More Popular:  While the 3-5-year range used to be the standard, auto loan lengths have been stretching out further and further over the past decade. Seeing loans for 6 or 7 years (72 to 84 months) is widespread.

In fact, Experian reports that the average loan term hit a record high of 73 months as of Q4 2022. Nearly 40% of new auto loans were between 61 and 84 months. The appeal of these longer loan terms is obvious: They lead to much more affordable monthly payments. Returning to our example above, stretching that loan out to 6 years would drop the monthly payment from around $670 to $485. However, let's also consider a 7-year loan term at a higher interest rate. This would result in a monthly payment of around $400, but the total interest paid over the life of the loan would be significantly higher.

Those lower monthly payments are handsome for many buyers who are already stretching their budget to the max. An extra $185 per month could make the difference between being able to afford that new car. But here's the catch - that longer loan term comes at a steep cost over time. If you stretched that same $30k loan to 72 months at 5%, your total interest charges would skyrocket to around $5,100. That's $1,800 more than you pay for he 4-year loan term. This should make you pause and consider the potential risks of longer loan terms.

So, in exchange for lower monthly payments, you're paying a lot more in the long run with a 6-year or longer auto loan. And that's if you keep the car for the entire loan term...

The Risk of Going Upside Down 

One of the most significant downsides of long auto loans is that you risk going 'upside down' on your loan, where you owe more than the car is worth. This is because new cars depreciate rapidly, losing around 20% of their annual value on average. Being 'upside down' means that if you were to sell the car, the amount you would receive would not be enough to cover the remaining balance on your loan. On a more typical 4-year loan term, you'll be roughly at the breakeven point by year 4, where you've paid off the loan balance to match the car's depreciated value.  

But look what happens with a 6 or 7-year loan term. Thanks to that rapid upfront depreciation, by year 4 or 5, you'll already owe more on the loan than the car is worth. This could limit your ability to maintain the car's value, as you may not be able to afford necessary repairs or maintenance, further decreasing the car's value.

This 'upside-down' situation can hurt you if you must sell or trade in the car before the loan is fully paid off. You'd have to pay off the remaining balance, even though the car's value wouldn't cover it. This could limit your ability to sell or trade in the car, as potential buyers or dealers may not be willing to pay the total loan balance. And if the car gets totaled in an accident? You're on the hook to pay whatever positive equity remains after the insurance payout. No fun at all.

So, Should You Ever Take a Longer Loan?

Given the downsides of long auto loan terms, you may wonder if they're worth considering. In some scenarios, longer loans make sense if you stretch your monthly budget.

For example, let's say you have excellent credit and qualify for a 6-year loan at around 3-4% interest. You run the math and realize the total interest cost over 6 years is $500-$700 more than a 5-year loan at a higher rate. The extra $100 interest per year might be worth it if those lower monthly payments are crucial for your budget. But you'd have to be disciplined about keeping the car until it's paid off to avoid going upside down. Additionally, a longer loan term could limit your ability to pay off other debts, such as credit card debt or student loans, which could have higher interest rates and more severe financial implications.

Financing for Longer Than 6-7 Years? Probably Not

While 6 or 7-year loan terms have become relatively common, some auto lenders will even offer you loan lengths of 8 years or more. You'll sometimes see loans as long as 9 or 10 years (108-120 months)!

However, most financial experts caution against auto loans this long, except in rare circumstances. They pile on even more interest charges over that longer timeline and significantly increase your risk of going upside down early on. Additionally, a longer loan term may make it more difficult to refinance the loan in the future, which limits our ability to take advantage of lower interest rates. By year 3 or so of an 8+ year loan, you're almost guaranteed to be in a situation where you owe more than the car is worth. This makes it extremely hard to get out of the loan if needed.

Personal Finance Guru Dave Ramsey famously calls auto loans longer than 4 years "Stupid Tax" and advises against a loan longer than 60 months on a new car.

The Reliability Factor

Beyond the financial ramifications, reliability must also be considered with longer loan terms. Realistically, cars become less reliable once you hit that 7+ year mark. So, if you're taking a 6- or 7-year loan, you'll likely have the car paid off around the age when repairs and maintenance costs start ramping up. But if you get stuck in an 8, 9, or 10-year auto loan? There's a good chance you'll be making payments long after the car has become more of a headache than it's worth.

Unless you can afford a new car payment once that ultra-long loan is up, it's generally advised to only loan terms up to 6 years. Remember, a longer loan term could limit your ability to save for other financial goals, such as a down payment on a house or retirement, which could have more long-term economic benefits.

Weigh the Total Costs, Not Just Monthly Payment

At the end of the day, loan term length is about balancing monthly budgeting realities and minimizing your long-term costs. While longer loans can make that new car feel more "affordable" from a payment standpoint, they often cost you thousands more over the full term. This knowledge empowers you to make a more informed financial decision. So don't just focus on getting the cheapest possible monthly payment. Consider the total interest charges over the life of the loan and aim for the shortest term you can reasonably afford.

If you need to stretch your loan out a bit longer for budgeting purposes, keep it at 6 years or less to minimize how much you'll pay and avoid going too far upside down too fast.

Looking at the big picture, total costs - not just the monthly payment - are crucial to not biting off more car loans than you can chew. With smart car buying and financing decisions, you can drive away happy while keeping more money in your pocket.

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