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How choosing the right loan term can get you in your car and keep you in your budget

Even with a decent trade-in value and some cash at the ready, chances are you’re considering financing part of that new car purchase. When shopping for loans, interest isn’t the only thing to consider; the loan term you select can have a big impact on the amount you end up paying.

Car loans are typically offered in 24-, 36-, 48-, 60- and 72-month terms. Borrowing the same amount of money at the same interest rate will lead to higher monthly payments for a shorter-term loan and a higher total amount paid (i.e., more interest paid) for a longer-term loan. Longer-term loans are more expensive overall but require lower monthly payments.

Ronald Montoya, a consumer advice editor for Edmunds.com, crunched the numbers on an average 2012 car purchase ($30,728 according to TrueCar.com data), using the rough average price of a new car during the year and a down payment of $3,435 (also an average taken from Edmunds data).

“After tax, title and the down payment, the total amount to be financed is $30,266. The average interest rate for a four-and-a-half to five-year loan in 2012 was 2.69 percent, according to Edmunds data. That person would have a monthly payment of $540. The finance charges over the life of the loan would be $2,115,” Montoya says.

Add two more years to the loan at the same interest rate and the monthly payment drops to $396, but the total cost finance charges go up more than $800, to $2,973. Take off two years to make it a three-year loan and the total interest paid drops to $1,272—but the monthly payment jumps to $876.

Saving $800 by getting a five-year loan instead of a seven-year loan, or saving even more by making it a three-year loan, is definitely enticing in the long term. But it’s a good deal only if you can afford the monthly payment. If your budget demands a lower monthly payment and you can afford the extra cash over a period of a few extra years, a longer-term loan might be a better option.

Things aren’t quite that simple, however. Longer-term loans often come with higher interest rates than do their shorter-term counterparts, which will not only increase the total cost of the loan still further but also raise the monthly payment on the loan.

“You might see loans that last 72 or 84 months. Run away from these as fast as you can,” warn the experts at Bankrate.com. “The interest rate on these kinds of loans will be a lot higher.”

Montoya’s data agrees. The average six- and seven-year car loan rates during 2012 weren’t the same 2.69 percent as the four-and-a-half- to five-year loan rates; they actually jumped up to 4.9 percent.

Using the same average purchase price and down payment with the adjusted interest rate, “the monthly payment for a seven-year loan, $426, would be lower than for the five-year loan,” says Montoya. “But the finance charges for the loan would be $5,548. That’s more than twice that of a five-year loan.”

While it is possible to find longer-term loans with competitive interest rates, you should be sure to talk to lenders about the specific rates and fees associated with loans of varying terms. And there are other advisers that agree with Bankrate.com’s aversion to longer-term loans.

“If you have to finance something for over 60 months, you shouldn’t be buying a car, or you should be getting into something cheaper,” says John Ulzheimer, president of consumer education at Credit.com. He does add, though, that if you can get the same interest rate over a longer period of time, it can sometimes be advantageous if you make early payments.

“While it is important to know what you can afford in terms of monthly car payments, that shouldn’t be your only measurement of a good car loan,” concludes Montoya. “Take a look at all the numbers in the sales contract so that you are fully aware of what you are paying for the car.”

Explore the options, keep an eye on interest rates and fees, and understand what a longer-term loan means for your future financial outlook—and what a shorter-term loan means for your present monthly budget.

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