How auto loans work, and how to make them work for you
The auto loan journey
Lender
A lender loans you money to buy a car.
- You can finance a car through an auto dealer who works with a lender, or directly from a bank or credit union.
- You agree to pay back the loan plus interest over a specific period of time.
- The lender holds a lien on the car—meaning it can repossess the car if you don’t make payments—until you’ve paid the loan in full.
Tip: Get quotes from different lenders and compare their terms. If two loans have the same terms, the loan with the lower interest rate will cost you less overall.
Down payment
You may need to pay part of the car’s price up front.
A down payment reduces the lender’s risk and offsets some of the value a new car will lose the first year you own it. In some cases, a vehicle trade-in may count as a down payment.
10.4%
The average car down payment in 2015, as a percentage of the price.
Source: Edmunds
A higher credit score can lessen your required down payment.
Paying more up front can lower your monthly payments and the overall interest you pay.
Terms
The term is how long you have to pay back your loan. Stretching the repayment over a longer period of time will also lower your monthly payments.
About 25% of auto loans have 49–60 month terms.
Over 40% of auto loans have 61–72 month terms.
Source: Experian, 2015
Tip: A longer term means higher interest costs. Try to choose the shortest term you can afford.
Interest rates
The annual percentage rate, or APR, is the interest rate plus any other fees the lender charges. As a result, the APR may be higher than the interest rate. Typically, the shorter your loan term and the higher your credit score, the lower your interest rate.
Depreciation
A new car’s value drops when you drive it off the lot. To avoid going “upside down” on your loan—owing more than the car is worth—try to make the biggest down payment you can manage.
After 3 years, new cars are worth about 40% less than purchase price.
Source: Edmunds, 2015
How much to spend on a car
Check your budget to see how much you can comfortably afford for a monthly car payment. Next, use an online calculator or ask a lender to determine what car price you can afford based on that monthly payment. Remember: The shorter your loan term, the less interest you pay overall.
