One of the reasons car finance has become such a popular way to fund the purchase of a new car is the amount of flexibility it brings. A wide variety of different finance providers offering a range of different products, means you can often tailor your car finance package to meet your exact requirements.

When you decide to go for a car finance deal, one of the first considerations you must make is how long you want the term length to be. Do you want to take out a long term or short term loan? Both have their pros and cons depending on your situation. Let’s take a look at both options in detail.

Long Term Loan

A long term loan is the more traditional form of car finance package. The term length tends to be from 48 months to 60 months, meaning you are paying off the cost over four to five years.

The big advantage of this is you get to spread the cost out over longer, meaning the monthly payments are generally a lot smaller than you would find in a short term agreement. Being able to keep your payments manageable means that if you have any big changes in your life, such as moving home, having a kid or changing job, then it will be easier for you to balance the budget then if you had a higher monthly payment to contend with.

The main disadvantage of a long term loan is that you end up paying more in terms of interest. The amount you are charged is based on the interest rate set at the start of the agreement. The longer it takes you to pay off the amount borrowed, the more you end up paying to the provider that is not going to be returned in value in terms of the car you finance.

Short Term Loan

In many ways, the short term loan is the inverse of the long term option. A short term loan is normally 18 to 24 months in length. You end up paying less interest because the amount of time you are borrowing for is much less. But the monthly payments are considerably higher as you have less time to spread the cost.

If you are in a steady position in life, i.e. a well-paying long term job, stable home or rental agreement, and not making (or planning!) any major changes to your family, then a short term loan can help you pay off the cost of your car much quicker.

So if you have a large monthly income, it can be a good way to spread the cost without having to pay off what’s owed for too long. Meaning you can then use the money you spent on monthly payments towards something else.

You will need to be able to prove you have the income to fund a short term loan, meaning you might need to provide payslips and bank statements for a longer period of time.

Personal Contract Purchase – Which Is Best?

The most popular type of car finance product is Personal Contract Purchase or PCP. So what length of loan works best for this product? The main factor for a PCP deal is that, in effect, you are not paying for the car, but instead paying the depreciation in value of the car over the length of the agreement.

In essence, the difference in value between the car at the start of the agreement and the end of the agreement. So a short term loan means you end up paying less, as there is less time for the car’s value to depreciate.

However, it gives you less flexibility at the end of the agreement. When a PCP deal comes to an end, you have three options. First, you can return the car to the finance provider/dealership. Second, you can use what you’ve paid on the car and use it as a downpayment or deposit on a new finance agreement.

And thirdly, you can pay off the remaining balance of the car in one large lump sum – known as a balloon payment. A short term loan means that the better option is to return the car to the finance provider. So if you want to effectively hire the car for the term length, then that’s where it works best.But you lose the value you have put into the car through your repayments.

You can get a long term loan on a PCP deal, many customers do. What you need to be aware of is that your car will depreciate more in value, so at the end of the agreement, you might want to consider refinancing a new car rather than paying the balloon payment, even if its more affordable than it would be in a short term loan.

Hire purchase - Which Is Best?

A hire purchase agreement spreads the entire cost of the finance package, including the interest charge, in the monthly payments. This benefits a long term loan, as you know exactly what the cost will be each month and can divide it into manageable monthly payments. While you might not benefit from variations in the interest rate because of the fixed APR, you do know exactly what you will be paying month on month.

The Importance of Deposits

Whatever loan option you decide to go for, a deposit can be vitally important in how you end up managing your finance package. A large deposit will reduce the amount you pay each month, meaning you end up paying less in terms of interest too. Should you decide you want a short term loan on a PCP deal, you need to carefully evaluate what you are planning to do at the end of the agreement, to ensure you don’t lose your investment in the vehicle.