What Is an Auto Loan?
In plain English
An auto loan is a secured loan used to finance the purchase of a vehicle, with the car serving as collateral. If you stop making payments, the lender can repossess the vehicle. Auto loans have fixed terms — typically 24 to 84 months — with fixed monthly payments that include both principal and interest calculated on an amortization schedule.
How Do Auto Loan Interest Rates Get Determined?
Auto loan rates are influenced by your credit score, the loan term, the age of the vehicle, the down payment size, and whether you use a bank, credit union, or dealership financing. Credit unions generally offer the lowest rates. Longer loan terms lower monthly payments but increase total interest paid. New vehicle loans typically carry lower rates than used vehicle loans.
What Is the Total Cost of Financing a Car?
The sticker price of a vehicle is just the starting point. You must also account for interest charges over the loan term, insurance costs, registration and taxes, and any add-ons financed into the loan. A $30,000 car financed at 7% over 72 months costs over $6,700 in interest alone. Running total cost calculations before agreeing to a loan prevents surprises.
Should You Lease or Finance a Vehicle?
Financing builds equity in an asset you eventually own outright. Leasing provides lower monthly payments and a new vehicle every few years but builds no equity and restricts mileage. If you drive many miles, customize your vehicle, or keep cars long-term, buying makes more sense. Leasing suits those who prefer lower payments, warranty coverage, and frequent upgrades without concern for ownership.
Frequently asked questions
What is a good interest rate for an auto loan?
Rates vary by credit score and market conditions. Borrowers with excellent credit (750+) may qualify for rates under 5% on new vehicles. Average borrowers typically see rates of 7–10%. Rates above 15% suggest subprime lending, and exploring credit unions or improving your credit before buying can make a significant difference.
How much should I put down on a car?
A down payment of 10–20% is recommended to avoid being immediately underwater on the loan. Because cars depreciate quickly, a small or zero down payment can leave you owing more than the car is worth shortly after purchase, creating financial risk if you need to sell or the car is totaled.
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Related terms
Principal
Principal is the original amount borrowed on a loan, separate from interest and fees. Reducing principal faster saves significant money over the life of the loan.
Amortization
Amortization is the process of paying off a loan through regular scheduled payments over time. Each payment covers both interest and a portion of the principal balance.
Loan-to-Value Ratio
Loan-to-value ratio (LTV) compares the loan amount to the appraised value of the asset securing it. Lenders use LTV to assess risk and determine mortgage insurance requirements.
Interest Rate
An interest rate is the cost of borrowing money, expressed as a percentage of the principal. It determines how much extra you pay on top of what you borrowed.
Loan Refinancing
Refinancing replaces an existing loan with a new one, ideally at a lower interest rate or better terms. It can reduce monthly payments or shorten the loan term.
Cosigner
A cosigner is someone who agrees to be equally responsible for repaying a loan if the primary borrower fails to pay. Cosigning carries significant financial and credit risk.