Choosing the Right Term: Deciding the Ideal Car Loan Duration

May 26, 2023

If you choose to finance a vehicle, how long should you finance it? In this highlight, we discuss our car buying guideline that we created to help you buy a car the smart way.

For more information, check out our Car Buying Checklist here.


Moving on to Ankita’s question, “why would it not be better to take a car loan for 60 to 65 months instead of 36 months to reduce your monthly payment so we can contribute more to the Roth IRA or 401k?” and she says, “I’m not buying a fancy car, just a regular car.”

So first of all, could you all tell everyone what your car buying rules are? And then speak to Ankita’s question. Brian, you want to talk a little about the car buying risk? I got a story to share that I think would be helpful. I’ll set up the car buying rules and Bo will probably give you the context on why, what’s the why on every one of these. First of all, 20 percent, that’s why. That’s the 20/3/8, so pay attention to these numbers. 20% down, so make sure you’ve got some skin in the game. Three years, that’s the amortization, meaning 36 months is if you’re going to have to finance this. We don’t want that amortization to go beyond three years. And then the last part, 8 percent. If you take your gross annual income and multiply it by 8 percent, you can quickly see, if you divide that by 12, what the monthly payment should be. And that’s just to make sure your eyes don’t exceed what your wallet and your purse can truly afford. Because I think a lot of people love faking it. And then the last rule is, if your car payment exceeds what your monthly investments are, you’re doing it wrong. You can’t have those two backwards. You need to make sure your monthly investments are larger than your car payment. Because that car payment is important, but the investments are what create wealth. And we want to make sure we pay respect to everything.

So, Ankita’s question is, “Well, okay, I get it guys, but man, 36 months? The car companies will let me do 72 or even 84 months now. If I get my payment super small, I can start saving. I can start building more wealth.” Here’s the problem with that. Not all assets are created equal. If you go to moneyguy.com, we’ve done a ton of shows on buying cars and how to think about buying cars. We have this chart that we show. I don’t think we have this one in the archives real quick to pull up, but it shows how rapidly automobiles depreciate in the first few years of ownership. They drop like a rock. So the longer you own a car, the less valuable it becomes. And the majority of that decrease in value happens in the early years. I have a dear friend of mine and he went to go buy a car. His family was growing and they needed to buy a family car. So he went and bought a car and he was responsible. He traded in a vehicle, so he had some down payment money. He put a little bit on top of that. But they said, “Hey, you know what? For the same interest rate, instead of doing this for 36 months, why don’t we finance this over 72 months? You can only pay this much down. It’s a much smaller payment.” And he had a baby on the way. So he’s like, “Oh, I’m gonna do that. Great.” So he does that, starts driving the car, everything’s great. By no fault of his own, like two years into the car, three years into the car, his wife was in an automobile accident. She didn’t do anything wrong. Something happened and the car is totaled.

The insurance company comes and they’re like, “Write a check, total the car.” Well, what he got for the value of the car once it was totaled actually turned out to be less than what the car loan was. So he’s in this position where now he’s gotta buy a new car. And while it wasn’t his fault and there was an insurance check, all that check did was allow him to start paying down some of the loan. He had to come out of pocket to finish paying off the loan and then buy another car. Now, yeah, there are some things he could have done if he bought gap insurance and these other things to put in place. But you know, the best thing that my buddy could have done was only finance it over 36 months. Because then, when he is two years into that car, even if this scenario happens, he has so much equity in the car that the loan is going to be minimal. It just protects you from having a depreciating asset drawn out over a long time. For a true financial mutant, I just don’t think there’s any need to do that.

Well, I think it’s a slippery slope if you have this decision that, you know, if you go from three years to 60 months, you’ll be like, “Well, what? You know, 50 bucks more a month, I could get that car.” I mean, that’s where our human nature goes. So I am pretty rigid on this, and I think, but I’m rigid with a dash of grace, and the fact that I know there are other pundits out there that tell you cash to the point that you’re supposed to go get classifieds or eBay motors or wherever people buy cars. But, no, you’re supposed to buy a two or three thousand dollar jalopy that you basically have to go out there and Fonzie every morning, put an ice cube on this place, heat it, pop it, to get to your job. Well, no. But that’s the thing. I grew up with a family of mechanics, so it made complete sense for my dad to have cars he could fix. Most of us don’t have that skill set. I sure don’t. So I’ve tried to come up with rules that give you the flexibility to actually have reliable transportation to get you to that important job that’s actually going to help you build wealth. But I also want to make sure it’s rigid. I want to challenge you so that you don’t turn our good-natured rule, which gives you some flexibility to ensure you have stable transportation and have your spouse and kids in something safe, and then turn it upside down by saying, “Well, you know what? 36 is good, but 60 months at this low interest rate is better. Now I can afford this nicer car.” And the Money Guy team won’t care because it’s still less than 8%. These are the types of games we play against ourselves. No. Take that grace that we’re giving you and the flexibility. Pay the car off in three years, and then the best driving car out there is the paid-for car. Absolutely.

For more information, check out our free resources here.



Most Recent Episodes

The Best and Worst Types of Life Insurance!

No matter how much you know about finance, you’ve definitely heard about life insurance: maybe from commercials pitching it as something to buy your baby, or a family member or friend that got into the industry. Is life insurance worth getting or something you should...

How to Recover From 4 HORRIBLE Financial Mistakes!

In our nearly four decades of combined experience managing money, we’ve seen some horrible financial mistakes - here are the four worst we’ve seen first-hand and what you can do to avoid making a similar mistake. In this episode, you’ll learn: The worst financial...

New Data: Active Investments Are Better Than Index Funds?

A new research paper is out that claims active funds from two large providers, Vanguard and Fidelity, beat their own index funds. Are active funds beating index funds? What’s going on here? Let’s find out! For more information, check out our free resources...

Why Americans Are Actually Broke! (2023 Edition)

Americans might be bad with money, but you don’t have to be. In this episode, we discuss the underlying reason why Americans are so bad with money and how you can do it better. In this episode, you’ll learn: Common financial pitfalls you should avoid Practical steps...

Build Wealth With the 3 Bucket Strategy! (By Age) 2023 Edition

We believe there are three distinct taxable buckets you have the option of investing in for retirement. We’ll talk about how to balance those buckets by age and show a case study by age that shows what your buckets may look like! In this episode, you’ll learn: The...

Debt Ceiling Crisis: World’s Financial System at Risk?

Should you be worried about the debt ceiling crisis? Although political leaders have so far been unable to come to an agreement, we'll tell you what history says will happen and what it means for your finances. For more information, check out our free resources...

Financial Advisors React to INSANE Money Advice on TikTok!

Is financial advice on TikTok all bad or is there some good advice out there? Check out our brand new TikTok react show where Brian and Bo give their honest reactions to trending financial advice. Enjoy the Show? Sign up for the Financial Order of Operation (FOO)...

How to Save Thousands of Dollars in Taxes in 2024

Tax season is over for most of us, but that doesn’t mean it’s time to stop thinking about your taxes! Planning out your tax strategy in advance can save you time and money on your taxes. In this Q&A, we’ll discuss the line items on your return to pay attention to...

Average 401(k) Balance by Age (2023 Edition)

Are you doing better than the average American at saving in your 401(k)? We'll talk about basics of a 401(k), including new limits, employer matches, and vesting schedules, how many millionaires are created by 401(k)s, and of course the average 401(k) balance by age....