Car Buyers Keep Focusing on Monthly Payment — But the CFPB Says Total Loan Cost Is the Number to Watch
It’s common to focus on the monthly cost of a car loan, since that’s what you’ll see leaving your bank account each month and what can impact your regular cash flow.
But the Consumer Financial Protection Bureau (CFPB) warns against exclusively making decisions based on the monthly cost. There are several factors to assess when comparing auto loans, and doing a bit of extra research upfront can save you money in the long run.
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Why shopping by monthly payment can cost you more
If you only shop by monthly payments, you may end up paying more in the long run. You can secure lower monthly payments by seeking an auto loan with a longer term, since spreading monthly payments over seven years instead of three years reduces your monthly bill. But you may end up paying more in interest over the life of the loan.
While a low monthly payment is still important for cash flow, don’t make the mistake of only viewing the monthly payment when determining if an auto loan is affordable.
For instance, a $40,000 loan at 6% annual percentage rate (APR) results in around $773 monthly payment over five years and roughly $6,400 in total interest expenses over the life of the loan. Getting the same loan amount and APR for a seven-year term results in a $584 monthly payment but $9,085 in total interest expenses. You save $189 per month with the seven-year loan but end up paying more than $2,600 in additional interest expenses.
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The numbers to compare before signing
The CFPB recommends looking at several metrics when comparing auto loans:
- Loan amount
- APR and interest rate
- Loan length
- Monthly payment
People who are tight on their finances may want to prioritize low monthly payments, but it will remain a line item in your budget longer. Individuals with some financial flexibility or the ability to cut back on some spending may opt for a loan with a shorter term to minimize how long they owe the debt and have to pay interest.
The CFPB provides a free loan-shopping worksheet that can help consumers assess the total cost of each auto loan before committing to it. The quicker you get out of debt, the less likely you are to refinance your auto loan, which would introduce additional costs.
Why this matters even more with today’s extra-long car loans
Longer car loans have become more common, and they can result in steady interest accumulation and monthly expenses that stay in your budget for longer. In July, Edmunds found that 36.5% of financed new-vehicle purchases in the second quarter had terms of 73 months or longer. A record 23.9% stretched out to at least 84 months.
Even with the stretched terms, the average monthly new car payment reached a record $777. Not only is that a big line item, but an extended loan also increases the risk of negative equity, which is when you owe more than the car is worth. Cars become less valuable over time due to depreciation.
Secure pre-approval or competing loan quotes before visiting a dealership. That can give you more leverage when negotiating a lower price for the vehicle so you don’t have to finance as much of the purchase. It’s also important to compare multiple offers.