Often, buying a car feels like a fraught process. You visit dealerships, go for test drives and try to find a car that fits your budget.
As you go through the motions, however, it can be difficult to stick to your budget. Dealers try to convince you to focus on monthly payments and affordability, rather than the total price of the car. One of the ways dealers do this is by encouraging seven-year car loans.
While a 7-year car loan might seem like the answer to your car affordability issues, it’s important to be careful as you move forward. Here’s what you need to know about these car loans./personal-finance/what-you-need-to-know-about-7-year-car-loans/
Why Do People Like Seven-Year Car Loans?
The main appeal of seven-year car loans is the fact that you can get by with a much smaller monthly payment. Let’s use a $25,000 loan with an interest rate of 3.11%. If you get a five-year loan, your monthly payment would be $450. With a seven-year loan, your monthly payment would only be $332.
Another advantage of a longer car loan is the fact that you can get a more expensive car. Spreading your loan out over a longer period of time makes monthly payments on larger amounts more manageable and it’s no surprise that it can be tempting to get a more expensive car.
Because it makes it easier to make monthly payments, and because it makes costlier cars feel more affordable, a seven-year loan seems like it can be a good choice. Unfortunately, many car buyers might feel remorse once they realize the realities that come with seven-year loans.
Related: How to Get the Best Auto Loan Rates
Costs That Come with Seven-Year Car Loans
Those lower payments come with costs. You might feel like you’re getting a good deal and that the car is more affordable, but the total cost could turn out to be much higher than you expected. Here are the costs that often come with seven-year car loans.
Higher Interest Rates
In many cases, a longer loan term translates to a higher interest rate. So, instead of getting the best interest rate, you might pay a premium. Let’s look at our example of a $25,000 car loan.
With a five-year loan, you might have an interest rate of 3.11%, with a total cost of the loan of $27,026. You would end up paying $2,026 in interest.
A seven-year loan, though, might have an interest rate of 6.11%. Now, your monthly payment would be $367, which is still lower than the $450 you’d pay on the five-year loan. So, you feel like this is still affordable, even with a higher interest rate. However, when you look at the total cost, the seven-year loan with a higher interest rate is $30,789. Your interest cost is $5,789, a difference of more than $3,000 paid in interest.
Longer Time in Debt
Part of the reason that a seven-year loan can be so much more expensive than a five-year loan (and certainly a three-year loan) is that you’re paying that higher interest rate for a longer period of time.
That combination makes for higher costs, but also the mental stress that comes with being in debt for longer. Once the excitement of buying a new car wears off, you realize that you’ll be paying off your vehicle for seven years. Unless you can tackle that debt and pay it off faster, you end up with long-term debt hanging over your head.
And, because the loan is secured with your car, if you miss payments, the lender can repossess it. If you know you need the car to get to and from work, the stress of knowing a financial setback or other issues could take that car away can impact you.
Depreciation and Being Upside Down on Your Car Loan
However, a longer time being in debt for your car also has other consequences. One of the biggest issues has to do with depreciation.
According to Carfax, you can expect a new car to lose 20% of its value in the first year and about 10% of its value each year after that. After two years of car ownership, you’d still owe $18,909.18 on your car, but it would only be worth about $18,000. If something happens to your car at that time, your insurance might not cover the total amount that you still owe.
Over time, you become less upside down on your loan, but it can still be stressful knowing that you owe more than your car is worth for a period of time.
Another pitfall of getting an 84-month loan is that you might not notice the cost of extras and upgrades. With the ability to get a more expensive car, you might not care as much when the dealer suggests adding an over-priced tow package or some sort of window tinting. After all, the car is still affordable and you can handle the monthly payments, so it’s easy to just finance extras.
Let’s say that you agree to $3,000 in extras and upgrades. Now, instead of financing $25,000, you’re financing $28,000. If you still have a 6.11% interest rate for seven years, now all of a sudden your total repayment is $34,483, and you’ll see another $694 in interest charges.
Plus, this also changes the mechanics of depreciation. At the end of your third year of paying on this higher loan amount, your car is worth about $16,200, but you still owe $17,442.42. It takes an extra year before you’re not upside down on your car payment when you add the extras to the equation.
Continuing the Cycle of Seven-Year Car Loans
All of this combines to make seven-year car loans more expensive than you thought, but what happens in five years when you feel like you’re ready to get a different car? You still have two years left on your loan.
This situation has resulted in many car dealers offering special deals. They pay off your old loan for you and roll the amount into financing for a new car. At the end of year five, including the cost of extras that you financed, you still owe $9,251.96 on the car. Carfax suggests that at this point, your car is probably worth about 40% of its original value, or about $10,000 using our example. You’re not underwater but barely above it.
Let’s say you want to buy a newer, more expensive car that costs $30,000. The dealer only offers $8,000 for a trade-in, bringing your cost down to $22,000. But you still owe that $9,251.96 on the old car. The dealer agrees to roll that financing into your new agreement, so you’ll finance $31,251.96. How will you afford that? With another seven-year car loan, of course!
As you can see, if you get a seven-year car loan, and you buy new cars regularly, it’s easy to fall into the trap of constantly being in debt as you purchase increasingly-expensive cars.
While most people will have to borrow some amount of money to afford a vehicle, it doesn't have to take 84 months to pay off. Be sure to shop around to find the best deal you can get.
When shopping for a vehicle, try to avoid falling into the trap of focusing on lower payments offered through seven-year car loans. Instead, focus on the total cost of the car and try to stick to your budget. Don’t be fooled by expensive extras or arguments that you could get a more expensive car and still afford the payments if you get a longer loan term.
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