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You can extend your car loan term — but that doesn’t necessarily mean you should.
Financing is a critical component of the car buying process. And when you take out an auto loan, you’re probably going to repay it in fixed monthly installments.
Considering new cars are about $48,000, you could be looking at a car payment of anywhere between $600 and $900 per month — or even higher. (Used cars are more affordable, but that’s a relative term these days.)
Wouldn’t it be nice to extend your car loan term and lower that burdensome monthly payment?
On the surface, a longer car loan term can seem appealing, especially if your personal finances are tight. But this move is not without repercussions. So, let’s explore if it makes sense for you to extend your loan repayment.
Yes, the easiest way to extend your car loan is by replacing it with a new loan with a farther out maturity date. This is known as refinancing, and it can help borrowers lower their monthly payments.
How? By spreading out your principal payments over a broader stretch of time. For instance, let’s say I lend you $100 under the condition that you repay me an equal amount each day for the next five days. So, you’d owe me $20 a day. However, if we push out your due date to 10 days, you’ll now owe me $10 a day instead.
The glaring hole in this example is that we’re ignoring interest — but we’ll come back to that shortly.
Refinancing your auto loan is similar to taking out your initial loan.
First, you’d check your credit to determine whether you’d qualify for auto refinancing. While eligibility varies from lender to lender, the average credit score of borrowers who successfully refinanced their auto loan in 2021 was 670, according to the RateGenius State of Auto Refinance report.
Keep in mind, this is an average — lower scores could still qualify and higher scores may not qualify. One reason is that your credit score is only one aspect of your loan application. Lenders also consider things like your vehicle and your income.
If you check your credit reports and realize you have bad credit, you may want to consider improving your scores first. This will increase your odds of getting approved for a new loan.
Once you feel confident about qualifying, you can start scoping out your lending options to find the best rates and terms — a process known as rate shopping.
There are countless financial institutions out there, from banks and credit unions to online lenders and dealership financing programs. So, while the most common refinance loan term is 72 months, it’s possible to find refinance loans as long as 120 months from select lenders. But these loans often have higher interest rates.
The decision to refinance for such a lengthy period of time depends on your individual situation, so make sure to crunch the numbers before going this route to see if it makes sense for you.
Here’s the better question — just because you can extend your car loan term doesn’t mean it is the best option for everyone.
Let’s walk through an example.
Imagine you took out a $20,000 auto loan in January. It’s a 60-month loan with an interest rate of 5%. That equates to a $377 monthly payment.
Fast forward to next January; your loan balance is down to around $16,000 — but your monthly payments are taking a toll. So, you decide to refinance. Your new loan is also 60 months, but thanks to an improved credit score, you’re able to secure a better rate of 4.5%. Go you!
Now, your monthly payment is $295, or $82 less than before. Seems like an all-around win, right?
Not necessarily.
Had you stuck with your original loan, you’d have $1,686 of interest left to pay. With your new car loan, you actually owe $1,897 of interest over the life of the loan — an extra $251. Maybe that’s not a crazy amount of money over five years, but still. It goes to show that extending your car loan term is not an open-and-shut case.
Original loan: $20,000 Monthly payment: $377 New loan: $16,000 Monthly payment: $295Example: Refinancing to Extend Your Car Loan Term After One Year
Original loan term: 60 months
Interest rate: 5%
Interest left to pay after a year: $1,686
New loan term: 60 months
Interest rate: 4.5%
Interest paid over life of loan: $1,897The Advantages of Lengthening Your Car Loan Term
The immediate benefit that likely comes to mind is a lower monthly payment. But as our example showed, it’s not quite that simple.
Let’s apply some context to see when it makes sense to extend your car loan term for this reason.
Auto loan refinancing can be a prudent financial move if you qualify for a significant interest rate reduction. This can offset any additional interest you’d pay over a longer term.
Maybe interest rates are lower than when you first took out your loan. Or perhaps your credit score and general financial situation have improved (like a new job with a higher paycheck). Regardless, if you can qualify for a better interest rate, you might be able to justify extending your loan term.
In 2021, the average borrower cut their interest rate by 7% when they successfully refinanced. That translated to $1,158 of average annual savings.
Curious to see what your new loan could look like? Research current auto refinance rates based on your credit score and calculate your savings.
Pushing out your loan term could increase the total amount of interest you pay on your loan. That said, if times are tight financially and there’s a light at the end of the tunnel — like a new job or some other source of income — you can free up some income by extending your loan term.
It’s not always the best option, but it is a short-term solution.
Debt isn’t inherently bad by any means. It helps people purchase things they couldn’t otherwise afford. And debt is a common way for people to finance vehicles, which are integral to daily life.
With that in mind, it’s generally better to pay off debt sooner rather than continue kicking the can down the road. Let’s explore the downsides of extending your car loan term.
Cars depreciate — it’s a fact of life. Unless you’re sporting around in a classic Porsche 911 or another vintage car, your car will depreciate too.
If your car depreciates faster than you can pay back your loan, then there’s a good chance you’ll be upside down on your loan and have negative equity in your car. This means your loan amount is higher than the value of your car — a metric known as your loan-to-value ratio (LTV).
For instance, let’s assume you take out a $20,000 loan with an 84-month term and forego a down payment on your $20,000 car. With an interest rate of 5%, you’ll pay off roughly 12% of your principal balance in year one.
However, some new vehicles can depreciate by as much as 20% in the first year of ownership. In this case, your LTV would be about 110%. And if you try to trade in or sell a car with negative equity, you’ll still owe money.
What does this have to do with your loan term?
By extending your loan, you’re more susceptible to the impact of depreciation. In the event of an emergency, like a major accident that totals your car, you could be in a financial bind. Because your car insurance policy may only pay out what the car is worth, which would still leave you short of what you owe your lender.
Fortunately, GAP waivers can protect you from this sort of scenario.
You’ve run the numbers — getting a new loan with an extended loan term makes sense financially. Except one pesky clause in your current loan agreement could derail the whole thing: prepayment penalties.
This type of fee is rare, although you may see it with a subprime loan. It’s simply the cost of repaying your loan early.
Lenders profit from loan interest. When loans have high rates, that’s more profit for the lender. But if the borrower repays the loan early, they miss out on those payments. Hence why some lenders institute a penalty for paying them back early.
A lower monthly payment seems nice in theory, but refinancing into a new loan with a longer term only makes sense if the savings outweigh the costs. Origination fees, admin fees, extra interest payments, and those pesky prepayment penalties — these things can add up.
Unless you’re in a bind, consider the cost implications of extending your loan term before you refinance.
Whether you want to lower your monthly payment just for the sake of savings or you’re truly in hot water, you aren’t limited to only one option. Let’s discuss a few plausible approaches.
Refinancing and extending your loan term can cost you more in the long run, depending on your new interest rate. However, if you want to lower your monthly payment without tacking on extra months of payments, you could refinance at a lower rate with roughly the same remaining loan term.
Let’s assume you’re about 12 months into a 60-month auto loan. (So, you have 48 months left until your loan matures.) Although you’d have to qualify, you might be able to secure a 48-month loan at a lower interest rate. In turn, you’d lower your monthly payment.
Just make sure to check your current loan agreement for any prepayment penalties, which could offset the cost savings.
If you’re on the fence about getting a longer loan term to reduce your monthly payment, consider the exact opposite approach (if you can swing it) — making higher monthly payments.
You could pay off a higher amount of your loan principal each month to reduce your total loan costs. While this won’t lower your monthly payment directly, the extra payments will accelerate the time it takes to pay off your loan — and save you money in the long run.
Using our example from earlier, if you paid an additional $50 on top of your typical payment amount of $377, you’d pay off your loan eight months sooner. On top of that, you’d save about $352 in interest.
If you’re struggling to make payments, it’s best to be transparent with your lender. They’d much rather help you get back on track rather than go through the onerous process of repossessing and selling your car.
While it depends on the lending program, your lender could move your payment date, set up a payment plan, or even extend your loan. For instance, a temporary lapse in income (like transitioning between jobs) could pose a risk to making a loan payment. By alerting your lender, they could move your typical payment date back to accommodate your next paycheck.
Or, if your financial hardship is a bit more prolonged, your lender may be willing to grant you a loan extension/deferral. This allows you to defer one or two (but rarely more) monthly payments. Keep in mind, this effectively extends your loan term — and interest doesn’t stop accruing, so you’ll pay more in the long run.
The decision to refinance or stick with your current auto loan depends on several factors. That includes your current loan term, interest rate, credit score, income, vehicle value, and general eligibility for refinancing. So, there isn’t a one-size-fits-all solution.
Still, it’s an avenue worth exploring — and you might even be able to refinance at a lower rate without extending your loan term. As a result, you’ll lower your monthly payment and save on interest.
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