Here's Why You Should Opt for the Shortest Car Loan Possible

Want to buy a car? Depending on what you're buying, you might need to cough up a bigger chunk of money than you're probably hoping. According to Kelley Blue Book, the average price for a new car was $48,808 as of March 2023, which was actually a decline of 1.1% from the month prior. KBB also found that in June 2023, the average used car went for $27,147. Unless you have a pile of cash waiting in your savings account, you'll likely need to finance a car purchase.

You might not have a ton of money available every month to dedicate to an auto loan payment, and taking on a longer loan term (say, six or seven years) is one way to cope -- if you get longer to pay the loan back, your payments will be smaller. But not so fast! A shorter loan term comes with solid financial benefits, if you can swing higher payments. Let's take a look at why it pays to sign on for the shortest car loan you can afford.

You'll pay less interest -- in two ways

Shortening your auto loan's term means paying less in interest. Of course, your total interest paid will be lower if you're only paying that interest on the loan over, say, five years instead of seven (more on that below). But also, you might qualify for a lower interest rate altogether for a shorter loan. Banks and lenders vary, but a car buyer having fewer years to pay on a loan reduces the risk for the lender. Simply put, you may be less likely to default on a loan if you're paying it for five years rather than seven. Lenders may be more comfortable extending you a lower APR if the loan will be paid off sooner and they're taking on less risk to lend to you.

As far as cash savings, here are some numbers for you. Let's say you've got a credit score of 700 ("good" for a FICO® Score), and have managed to snag an auto loan for a $30,000 new car at 14.09%, with 20% down ($6,000). According to U.S. News & World Report, this is the average new car loan APR for August 2023 for your credit score. Let's take a look at how much interest you'd pay based on a few loan term lengths:

The money saved by going with a shorter loan (if you can cover the higher payments) is significant -- over $4,300.

There's less financial risk for you

If you're paying for your car for fewer years before you own it outright, you're less likely to end up underwater on the loan. This happens when you owe more money on the car than what it's worth. If you intend to keep the car for many years, this may not matter to you.

But what if something happens to it while you're still paying off the loan? If you get in a car accident and your auto insurer considers the vehicle a total loss, you'll receive a check for the value of it. But if you still owe $15,000 on your $30,000 car, and your insurer says it's only worth $12,000, you'll have to come up with the remaining $3,000 you owe on the loan.

Once your car is paid off, you could save on insurance costs

Speaking of your auto insurance, you could save money on that by paying off your car sooner, too. Once the car is fully paid off and you own it outright, you can reduce your insurance coverage. Your lender likely required you to carry full coverage, but you have the option to lower your coverage to liability only. I don't necessarily recommend this move, especially if the car is still worth a chunk of money, for your own financial protection -- but it is an option.

Buying a car is a big financial move, and it's certainly understandable if you can't manage the higher payments that will come with a shorter loan term. But if you can, paying off your car sooner can benefit you in all these ways.