This is part of a series covering all the terms you need to know if you’re buying a fresh or used car from a dealer. Check out the rest of the series in our Car Buyers’ Glossary.
Few people pay 100% cash upfront when purchasing a fresh car, so the two most common methods of purchasing a fresh car are leasing or financing a fresh car with a loan from a bank or financing company. Both the lease and the payment plan are structured to last for a set period of time, often several months or years. This agreed length is called the lease term or loan term.
What is the difference between a leasing term and a loan term?
Basically, leasing means paying money to rent a car over an extended period of time, while a loan slowly pays you money to eventually own the car. All else being equal, leasing will cost less per month because you only pay for what you apply and don’t retain ownership of the car at the end of the lease. The lease period is usually from 24 to 36 months. The average fresh car loan in the United States is currently approximately just underneath 70 months.
How long can you finance a fresh car?
The loan repayment plan can range from low to long, as the customer largely determines the length of the loan. The most popular loan period is 72 months, but even longer loans are becoming more and more popular. For example, as vehicle prices rise, 84-month (and even 96-month) loans are now increasingly being offered. These loans offer smaller monthly payments, which are attractive to many buyers, and usually require smaller down payments. However, this can be a very bad financial decision, depending on the interest rate.
Leasing has some advantages. There will likely be a lower down payment, lower monthly payments, and because the lease will cover the vehicle’s warranty, maintenance and repair costs will be reduced. It also allows you to easily change your vehicle to a fresh one after a low time. However, disadvantages often include mileage limits, excess wear and tear fees, and other fees and conditions that can add hundreds of dollars at the end of the lease. And of course, you can’t keep the car (unless you apply the clause in your lease to purchase it) or get your money back when it’s time to return it.
How do you finance a car?
You can finance a car by taking out a loan through a bank or financing company. When buying fresh, dealers will usually encourage you to finance through them, but you don’t have to do that. It is advisable to shop around (especially with your bank) to see what terms you can negotiate before entering the dealership.
Can I trade in a financed car?
Yes, when you finance a car, you pay to own it, so when the leasing period ends, you own the car and can trade it in for anything else. You can also ride as long as you want. Of course, there are no mileage restrictions, but it’s not completely yours until the loan is paid off and you receive the title. You can also trade in the car while you’re still paying off the loan, but keep in mind that no matter what you trade it in for, the cash you’re offered will first have to go towards paying off the entire loan before you pocket (hopefully) the extra money.
Can you return a financed car back to the dealer?
Dealerships usually do not allow you to return your car after purchasing it, but there may be some extenuating circumstances that allow you to do so immediately after purchasing it. If something in the contract is against the law or the dealer’s policy of allowing you to return the car after a certain period of time, it may be possible to do so, but in most cases you will not be able to return the brand fresh car you just financed.
Which is better: short-term or long-term?
In practice, all loans are short-term, lasting two to three years. The loan can sometimes be extended to five years, but this is unusual.
Longer loans tend to be more high-priced in the long run because you’ll pay more in interest. These interest rates also tend to be higher. A shorter loan will mean a higher down payment and larger monthly payments, but it will cost less in the long run.
What terms are fair for the customer?
You might think it’s better to go with a plan that offers cheaper monthly payments, but it’s actually best to keep your loans low. Owing someone money for anything less is always a good move – it usually lowers the interest rate, lowers the total amount of interest paid, and allows you to own (and perhaps sell) sooner. Therefore, it’s best to aim for a loan between 36 and 60 months, as it should offer the best overall deal – lower overall interest payments, a lower interest rate, and a term that better suits the length of time most people own a car. Honestly, if you can’t afford the resulting monthly payment, this car is probably too high-priced.
If you think you’ll be ready for a different car in a few years, you’ll want to do a few things. First, consider leasing. If you’re the type of person who likes a fresh 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 whether you can expect any upcoming life changes. You don’t want to be in the second year of leasing a sports car when your triplets are born. There are several ways to get out of a lease, but none are perfect or particularly straightforward.
However, even if you’re sure you’ll apply your car longer than average and get every penny out of it, consider a shorter loan term and total costs instead of focusing on monthly payments. It will present what you can actually afford in a more realistic way.
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