How Long Should Your Car Loan Be?

I’ve often had clients ask me which car loan they should take - usually either the 5-year or 7-year loan. Do you know which is better? Let’s find out.

For simplicity, let’s consider the simple car loans also known as ‘hire purchase’. There also exists ‘flexi’ car loans, but those are more similar in function to home loans so we’ll cover them another time. Additionally for reference, most hire purchase loans come in 3, 5, 7, or 9 year loan tenures.

Ok, let's get some basics out of the way. Hire purchase loans are what we call fixed-rate loans. This means that the interest rate is fully applied on your loan amount right from the start (you can check out my previous topic on floating and fixed-rate loans if you want to delve deeper).

So what this means is that all the interest that would be charged to you over your loan tenure is already factored into your monthly repayment. Paying faster does not save you any interest. I repeat again, paying faster does not save you any money. So if you have a 5-year loan, you’re locked into paying 5 years worth of interest. If instead it was a 7-year loan, you’d be paying more interest: 7 years worth.

What’s the advantage of a longer loan tenure then? That would be the amount of monthly repayment. The longer the loan, the lower the repayment.

Nowadays, banks do give some sort of interest rebate if you fully settle your loans early. So some people may opt for a longer loan just in case they need the cashflow. It is important to note however, that your total costs for a straight 5-year loan is usually lower than taking a 7-year loan but paying it off in 5 years.

Knowing all this, the decision of which loan tenure to take comes down to which one makes more financial sense.

If you are a salaried employee or any other position where your income is fairly static, then I would recommend you to take the shortest loan tenure that you can comfortably afford. There’s no reason to pay more interest if you don’t need to.

On the other hand if you are a business owner, earn via commission, or have a fluctuating income, then you may stand to gain from good positive cashflow. These positions commonly have ways to increase income further, usually requiring some reinvestment of cashflow into things like operations or marketing expenses. If this applies to you, then going for a longer loan tenure may actually be better as the cashflow you save may generate more income for you (compared to only saving on the interest rate).

Whatever your situation, I strongly recommend you consider loan tenures up to a maximum of 7 years only. If you have to take a 9-year loan, you cannot afford the car.