This is part of a series breaking down all the terms you need to know if you’re buying a new or used car from a dealership. Check out the rest of the series at our Car Buyer’s Glossary.
Few people pay for a new-car purchase with a 100-percent up-front cash payment, so the two most often-used methods of getting a new car are leasing it, or financing a new car via a loan from either a bank or a financing company. Both the lease and the payment plan are structured to last through a certain amount of time, often several months or years. That agreed-upon length is called the term of the lease or the term of the loan.
What’s the difference between a lease and a loan term?
Essentially, a lease is paying money over an extended time period to rent a car, while a loan is slowly paying money toward eventually owning the car. All other things being equal, a lease will cost less per month because you’re only paying for what you use, and you don’t retain ownership in the car after the lease term is over. The term of a lease is usually 24 to 36 months. The average new car loan in the United States now stretches to just under 70 months.
How long can you finance a new car?
A payment plan for a loan can range from short to long, as the customer largely has the say in the length of the loan. The most common loan term is 72 months, but even longer loans are becoming common. For example, 84-month (and even 96-month) loans are being offered more often these days as vehicle prices go up. These loans offer smaller monthly payments, which are attractive to many shoppers, and usually require smaller down payments. However, it could very well be a poor financial decision depending on your interest rate.
A lease has certain perks. There will likely be a lower up-front down payment, lower monthly payments, and as the lease will coincide with the vehicle’s warranty, maintenance and repair costs will be limited. It also allows for easy turnover to a new vehicle after a short time. However, downsides often include mileage limits, excess wear charges and other fees and conditions that can add hundreds of dollars at the end of the lease. And, of course, you don’t get to keep the car (unless you exercise a clause in the lease agreement to purchase it) or make any money back when it’s time to return it.
How do you finance a car?
You can finance a car by obtaining a loan through a bank or financing company. When buying new, dealerships will typically steer you into financing with them, but you’re not required to do so. It’s recommended that you shop around (specifically with your bank) to see what sort of terms you can negotiate ahead of stepping foot into the dealership.
Can I trade in a financed car?
Yes, when you finance a car, you’re paying to own it, so once you’ve reached the end of the term, you own the car and can trade it in for whatever else you might want. Or you can keep driving it as long as you’d like. There are no mileage limits, of course, but it’s not strictly yours until the loan is paid off and you get the title. You can trade the car in while you’re still paying money toward your loan, too, but keep in mind that whatever you trade it in for, the cash you’re offered will first need to go toward paying off your loan in full before you pocket (hopefully) any extra money.
Can you return a financed car back to the dealer?
Dealerships typically don’t allow you to return a car after purchasing it, but there could be some extenuating circumstances that would allow for such an action to be taken directly after purchasing it. If something about the deal runs counter to laws or a dealership as a policy allowing you to return a car after a certain time period, then it may be possible, but in most cases, you won’t be able to return a brand-new car that you just financed.
What’s better: short-term or long-term?
In practical terms, all loans are short-term, lasting two to three years. A loan can occasionally extend up to five years, but it is unusual.
Longer loans tend to be costlier in the long run since you’ll be paying more in interest. Those interest rates also tend to be higher. A shorter loan will mean a higher down payment and larger monthly payments, but will cost less in the long run.
What is a fair term for a customer?
One might think it’s better to go with a plan that has cheaper monthly payments, but it’s actually best to keep loans short. Less time owing anybody money for anything is always a good move – it usually reduces the interest rate, lowers the total amount of interest paid, and lets you own it outright (and perhaps sell it) sooner. It’s therefore best to aim for a 36- to 60-month loan as it should deliver the best overall deal – lower total interest payments, a lower interest rate, and a term that better fits the length of time most people own a car. Frankly, if you can’t afford the resulting monthly payment, that car is probably too expensive.
Now, if you think you’ll be ready for a different car within a few years, you’ll want to do a few things. First, consider a lease. If you’re the type of person who likes a new car every two or three years, you’re exactly the type of person for whom leasing makes the most financial sense. That said, before choosing a lease, consider if you might have any upcoming life changes. You’d hate to be in year two of a sports car lease when the triplets are born. There are some ways to get out of a lease, but none are ideal or particularly easy.
Yet, even if you’re sure you’ll keep the car longer than average and get every penny’s worth out of it, consider a shorter-loan term and the total costs rather than focusing on monthly payments. It’ll put what you can actually afford in more realistic terms.
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