Navigating Auto Financing: Pros and Cons of Long-Term Amortization
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By Karen Barrett Bromwich+Smith Staff | 1054 words | Reading Time: 5 minutes | Date: 2023/10/19
There are a lot of emotions that can go into purchasing a new or used vehicle. You may be eying that vehicle of your dreams, require a larger vehicle for your growing family or possibly something more reliable than your current vehicle. There are a few things to consider prior to signing the contract and the term or amortization is just one of them. It’s important to put your emotions aside and understand that purchasing a vehicle is typically the second largest purchase (aside from a house) you will ever make.
Pros and Cons of Longer Terms or Amortization Periods
What is term or amortization?
Term or amortization is the amount of time over which a loan’s payments are calculated. This can enable you to spread a loan payment out over a longer period, making the payments more affordable. Early in the loan a larger portion of the payment will go towards interest, as you continue making payments this will gradually shift towards principle.
When we think of term and/or amortization, you may be thinking of mortgages. With auto financing you could be offered a straight term/amortization where the term and amortization are the same (this is the most common) which can be up to 8 years (making payments for 8 years will pay the loan in full) or you can have a term of 5 years with an amortization of between 6 – 8 years. This means that after 5 years of making payments the remaining balance (residual) could either be refinanced at the current interest rates or you could pay it in full.
Long term/amortization pros:
Smaller monthly payments
Allows you to purchase a more expensive vehicle
Opportunity to build credit over a longer period
Long term/amortization cons:
If you trade the vehicle early or frequently, this could put you in a negative equity position or “upside down” meaning you owe more for the vehicle than what it’s worth.
Pay interest for a longer period
Interest rate could be higher
Warranty on the vehicle could expire prior to the loan being paid
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Benefits of a shorter-term loan
Pay off the loan faster
Possibly receive a lower interest rate
Can prevent owing more on the vehicle than what it’s worth
How to pay off your loan faster
Make bi-weekly payments – pay approximately half your loan payment every 2 weeks (26 payments in a 12-month period). This will help to pay down the interest faster and in turn pay off the loan a bit quicker.
Make lump sum payments. You can pay down or pay off the loan at any time. Ensure you advise the lender that the payment is to go towards principle.
Pay more than your minimum payment. No matter how big or small that amount is, every little bit helps. As with the lump sum payment, ensure you advise the lender that the payment is to go towards principle.
When negotiating the finance terms of your new vehicle, determine if the amortization period of the loan fits with the length of time you plan to keep the vehicle, possibly up to 7 or 8 years. If you are accepting a longer amortization period to purchase a vehicle that you would not normally be able to afford or may not keep past 4-5 years, this longer term may not be in your best financial interest.
By Karen Barrett - Auto Dealership Partner Specialist
Karen has been in the finance industry specializing in automotive finance for over 2 decades. Karen has seen many people overextend their finances due to a vehicle purchase they may not have fully understood. She encourages everyone to read and understand any contract prior to signing it. If you don’t agree…. don’t sign!
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FAQ Related Pros and Cons of Long-Term Amortization:
1: What is term or amortization in the context of auto financing?
Term or amortization refers to the duration over which a loan's payments are calculated. It allows you to spread the loan payment over a more extended period, making monthly payments more affordable.
2: Can you explain the pros of a longer-term or amortization period in auto financing?
A smaller monthly payment.
The ability to afford a more expensive vehicle.
Opportunity to build credit over an extended period.
3: What are the cons of opting for a longer-term or amortization in auto financing?
Risk of negative equity if the vehicle is traded early.
Paying interest over a more extended period.
Potential for a higher interest rate.
Warranty expiration before the loan is paid off.
4: What are the benefits of choosing a shorter-term loan for auto financing?
Faster loan payoff.
Possibility of a lower interest rate.
Reduced risk of owing more on the vehicle than its worth.
5: What are some strategies to pay off an auto loan faster?
Make bi-weekly payments, roughly half the monthly amount every two weeks.
Consider making lump sum payments towards the loan principal.
Pay more than the minimum payment regularly.
Evaluate the amortization period based on how long you plan to keep the vehicle.
6: How can making bi-weekly payments benefit the payoff of an auto loan?
Making bi-weekly payments involves paying approximately half of your monthly loan amount every two weeks (26 payments in a year). This helps pay down the interest faster, accelerating the overall loan payoff.
7: Is it possible to pay off an auto loan with a lump sum payment, and how should it be done?
Yes, you can pay off an auto loan with a lump sum payment. Ensure you inform the lender that the payment is intended for the principal amount to have the most significant impact on reducing the total loan balance.
8: Why is it advisable to pay more than the minimum payment on an auto loan?
Paying more than the minimum payment, regardless of the amount, contributes to reducing the principal balance faster. It helps in paying off the loan quicker and potentially saves on interest costs.
9: How should one negotiate the finance terms for a new vehicle concerning the loan's amortization period?
When negotiating, align the amortization period with how long you plan to keep the vehicle, up to 7 or 8 years. Avoid accepting a longer term if it doesn't match your vehicle ownership plans, as it may not be in your best financial interest.
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By Karen Barrett - Auto Dealership Partner Specialist at Bromwich+Smith
Karen has been in the finance industry specializing in automotive finance for over 2 decades. Karen has seen many people overextend their finances due to a vehicle purchase they may not have fully understood. She encourages everyone to read and understand any contract prior to signing it. If you don’t agree…. don’t sign!