In the early 1980s, Chrysler began offering longer vehicle warranties, and their competition quickly followed suit. Build quality improved drastically and, as a result, long-term financing became possible. Now, more than half of car loans in Canada are financed for 84 months or more.
This makes having a proper understanding of car loan amortization more important than ever.
What Is Car Loan Amortization?
Amortization is a term referring to the process of spreading the cost of an intangible asset (such as debt) over a certain period. It's what gives us the ability to pay off a car loan in fixed monthly installments.
Early on, most of the car payment will go towards interest. As time goes on, the ratio of principle to interest will shift. This ensures that the financier always gets what they're owed.
Car Loan Amortization Terms Banks Make Available
Banks are pretty risk-averse.
As a result, they consider the age of the vehicle when determining the acceptable length of car loan amortization. With the multitude of extended warranty options available, the 3-year-old car of your dreams, with an extended warranty and a 72-month amortization could be exactly what you need.
Though these offerings vary by bank and credit score, most financial institutions offer the following options:
Loan eligibility based on vehicle age:
Current year plus seven prior years: 60 months
Current year plus three prior years: 72 months
Current year plus one prior year: 84 months
How Does Longer-Term Car Loan Amortization Affect Your Monthly Payments?
Do you have a monthly budget in mind? Do you want to get the most for your money?
Choosing a longer term loan can allow you to buy a more expensive vehicle for the same monthly cost as a lower-priced one. What's great is that you can use the extra purchasing power to buy a vehicle with enhanced safety features or additional cargo space.
Imagine you have a fixed budget of $500 a month. Even with a higher interest rate, the longer-term loan gives you $7100.00 in additional purchasing power!
Shorter Term Option
Your Monthly Payment: $500
Your Term Period: 5 Years
Interest Rate: 7.5%
The Value of the Vehicle You Can Afford: $25,000
Longer Term Option
Your Monthly Payment: $500
Your Term Period: 7 Years
Interest Rate: 8.0%
The Value of the Vehicle You Can Afford: $32,100
*Chart is for illustrative purposes only. The example assumes the term equals car loan amortization.
Initially, the seven-year loan seems like a no-brainer, but that's not quite true! While longer-term car loans benefit someone, it's not you, it's the bank.
4 Reasons You Might Want to Go with A Shorter-Term Car Loan
While a three-year car loan might strain your wallet in the immediate future, it will pay off in the long run. There are four things tipping the scale in favor of short-term loans:
- It Gets You Out of Debt Faster: You might be broke for a couple of years, but a shorter-term loan makes it easier to move on to the next great thing. If you opt for longer-term car loan amortization, you might have to wait a few years for that boat, house, or RV.
- They Usually Have Lower Interest Rates: Since they're less risky to the bank, short loans usually come with lower interest rates. This means you'll end up paying less for your vehicle than someone who opted for a five- or eight-year loan term.
- It Stops You from Owing More Than Your Vehicle is Worth: The average vehicle loses up to up to 20-percent of its value in its first year on the road. When you take out a loan for five to seven years, you're likely to end up underwater. For people living paycheck to paycheck, this is a dangerous situation.
- You Can Drop Full Coverage Sooner: Not owing on your car gives you a few ways to save on car insurance. While we're not recommending you do this, it's a good card to have.
For people with poor credit , the benefits of a long-term loan can outweigh the risks. Whether or not this is the case depends wholly on your needs, your budget, and your credit history.
3 Ways to Make Car Loan Amortization Work for You
Even if you get a five or six-year car loan, there's no reason you can't pay it off sooner. There are three ways to do this:
- Make Lump Sum Payments: While that yacht looks tempting, you'd be better off putting your inheritance towards your car loan. This helps you save on interest and significantly lowers the amount owed.
- Make Bi-weekly Payments: Instead of paying monthly, pay half that amount every two weeks. This will allow you to make 13 months' worth of car loan payments in a 12-month period.
- Pay More Than Your Minimum Payment: Even if it's just $10 a month, that extra cash can help you pay your loan off more quickly. Just make sure you designate this money as a "payment toward principle."
Get Ready to Drive Off in the Car of Your Dreams
Hopefully, your eyes won't cloud over the next time your banker starts talking loan terms and car loan amortization. Regardless of the terms of your loan, Car Loans Canada is here for you. Fill out our application and get pre-approved for a car loan!