What Is an Auto Loan?
An auto loan is a type of installment credit used to purchase a vehicle. You borrow a set amount of money from a lender, agree to repay it over a fixed term, and the vehicle itself typically serves as collateral. If you stop making payments, the lender may repossess the car.
Auto loans are common for both new and used vehicles, and the terms can vary widely based on the lender, your credit profile, and the vehicle's price.
- Fixed repayment schedule: usually monthly payments over a set period, such as 36, 48, 60, or 72 months.
- Secured by the vehicle: the lender holds a lien until the loan is paid off.
- Interest and fees apply: the total cost includes the principal plus interest and any applicable fees.
auto loans
Auto loans come in different forms, and the best choice depends on your situation and the vehicle you are buying. Here are the main categories:
- New car loans: often have lower interest rates and longer terms, but the vehicle depreciates quickly.
- Used car loans: typically have slightly higher rates than new car loans, but the purchase price is lower.
- Refinance loans: replace your existing auto loan with a new one, often to get a lower rate or change the term.
- Lease buyout loans: finance the purchase of a vehicle at the end of a lease.
Key Terms: Principal, Interest, and APR
To understand an auto loan, you need to know a few essential terms:
Principal is the amount you borrow, not including interest or fees. Interest is the cost of borrowing money, expressed as a percentage of the principal. The annual percentage rate (APR) reflects the total yearly cost of the loan, including interest and certain fees, expressed as a percentage. APR gives you a more complete picture of the loan's cost than the interest rate alone.
- Principal: the loan amount, e.g., $20,000.
- Interest rate: the nominal rate used to calculate monthly interest, e.g., 6% per year.
- APR: includes interest plus origination fees or other costs, so it may be higher than the nominal rate.
How Auto Loans Work
When you take out an auto loan, you agree to repay the principal plus interest over a set period. Your monthly payment depends on the loan amount, the interest rate, and the loan term. Longer terms usually mean lower monthly payments but more total interest paid over the life of the loan.
The lender places a lien on the vehicle title. Once you pay off the loan, the lien is released and you own the vehicle outright. If you default, the lender can repossess the car to recover the remaining balance.
- Loan term: commonly 36 to 72 months, but some lenders offer longer terms.
- Down payment: an upfront payment that reduces the principal; a larger down payment can lower your monthly payment and total interest.
- Trade-in: you can use the value of your current vehicle to reduce the amount you need to borrow.
Common fees
Beyond interest, auto loans can include various fees. Knowing these upfront helps you compare offers from different lenders.
- Origination fee: a charge for processing the loan, sometimes included in the APR.
- Documentation fee: a dealer or lender charge for preparing the paperwork.
- Late payment fee: charged if you miss a payment deadline.
- Prepayment penalty: a fee for paying off the loan early (not all lenders charge this).
Frequently asked questions
What is the difference between APR and interest rate?
The interest rate is the nominal rate used to calculate the cost of borrowing, expressed as a yearly percentage. The APR (annual percentage rate) includes the interest rate plus certain fees, such as origination fees, giving you a more complete cost figure. For comparing loans, the APR is generally a better tool.
Can I get a loan with bad credit?
Yes, you can get a car loan with bad credit, but you may face higher interest rates and stricter terms. Some lenders specialize in subprime auto loans. To improve your chances, consider a larger down payment, a shorter loan term, or a co-signer with better credit. Compare offers from multiple lenders to find the best available terms.
What is a typical loan term?
Typical auto loan terms range from 36 to 72 months, though some lenders offer 84-month loans. Longer terms lower your monthly payment but increase the total interest paid. A shorter term can help you build equity in the vehicle more quickly.
How much down payment is recommended?
A common recommendation is to put down at least 10% to 20% of the vehicle's purchase price. A larger down payment reduces the amount you need to borrow, which lowers your monthly payment and the total interest cost. It may also help you qualify for a better interest rate.