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When you’ve got your eye on a car, it’s easy to leave the financing for later. But understanding how car loans work, how the application process flows and the red flags to watch out for can help you save and get you on the road faster.
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How do car loans work?
A car loan is a type of financing used specifically to purchase a new or used car. After buying the car, you’ll make monthly payments of both principal and interest until the loan is fully paid off. Auto loans are usually secured loans — the car itself is used as collateral and can be repossessed if you don’t make payments.
How much you can borrow and what interest rate you get depends on the lender and your personal financial situation. The best way to ensure you’re getting the best deal available to you is to compare offers from multiple lenders before signing on to any car loan.
LEARN MORE: What is an auto loan?
How much do car loans cost?
When it comes to how much you’ll pay for financing, you need to factor in both ongoing costs built into the loan and upfront costs.
- Interest rate. The average car loan rate is around 7%. The lowest rates hover around 3%, though these are reserved for individuals with excellent credit and a low debt-to-income ratio. Borrowers with poor credit usually see rates in the double digits.
- Fees. Some lenders charge an origination fee of 1% to 5% of the loan amount. Your loan’s APR is interest and fees expressed as a percentage.
In addition to APR, the length of your loan term also affects the overall cost. Your loan term is the amount of time you have to pay off your loan. A short loan term generally results in higher monthly payments, but a lower total loan cost. A longer loan term gives you lower monthly payments, though you’ll ultimately pay more in interest.
After your APR and term, you’ll want to pay attention to how much you’ll have to pay up front and in taxes:
- Down payment. How much you’re expected to put down affects the immediate cost of your car loan. Expect to pay 10% to 20% of the cost of your vehicle up front.
- Sales tax. Each state requires different sales tax, typically available on your local DMV site. Make sure to factor in sales taxes when estimating the cost of your car.
Don’t forget to ask about any rebates you might be eligible for
If you’re financing with a dealer, ask about any cashback discounts to avoid leaving money on the table. Three main types include cash rebates, low-interest dealership financing and special leases. Government rebates for low-emission or hybrid vehicles are also available in many states.
What about 0% APR financing?
Some dealerships offer interest-free financing, but it’s not always easy to get. Keep these drawbacks in mind before signing on to 0% APR financing:
- It’s a marketing tool. Generally, interest-free financing is a marketing tool that manufacturers use to bring in customers.
- Not everyone is eligible. You need to meet tough credit and income standards to qualify — only around 10% of applicants actually qualify for the 0% rate.
- Higher monthly payments. These loans tend to be shorter — often no more than 36 months — translating into high monthly payments.
- Less room to negotiate. This type of financing tends to come with a fixed price, and you often can’t qualify for a cashback rebate.
- Your deal might be canceled. You might have to pay full interest if you miss just one payment.
Just some of the top car loan providers we review
Where can I get a car loan?
Back in the day, your financing options were limited to dealerships and affiliated lenders.
Now you have more options beyond traditional financial institutions, including online upstarts competing for your business.
- Banks. Chances are that your bank offers auto financing or a personal loan you can use to purchase a new car. It’s a relatively hands-off experience, and only applicants with good credit typically qualify.
- Credit unions. Credit unions often offer financing with lower rates and more lenient credit requirements. But you need to join to qualify, which can add time to the process.
- Online lenders. Online loan providers can offer faster funding for people with damaged credit or who are new to auto financing. Some can also help you find a car at a dealership.
- Online connection services. Loan connection services could be an ideal option if you have bad credit, since many offer loans with low or no credit requirements — though it won’t be cheap.
- Dealerships. You can always try to get financing directly from your dealer, though you might need to become a master negotiator to dodge typical dealership tactics.
How to compare car loans
Before you compare lenders, calculate how much you can afford to pay for a down payment, monthly repayments, any fees and your loan’s overall cost. Look up your state’s taxes and fees associated with purchasing a car, and add them to the cost of each lender you’re considering.
- Check if you’re eligible.
There’s no point in applying for a loan if you and your car don’t meet the lender’s minimum requirements. You can typically find these requirements on the lender’s website or in online reviews.
- Know how much you can borrow.
Does the lender offer loans that cover the total cost of a car you’re interested in — and can afford?
- Find out the interest rate.
A high minimum advertised interest rate isn’t the best sign, and a refusal to disclose interest rates can be even worse. It could mean that rates are so high, the lenders would rather not advertise them.
- Understand the fees.
On top of dealership and state fees associated with buying a car, some lenders charge fees for taking out a loan.
- Decide if the loan term fits your budget.
Does your lender offer terms you can afford after you factor in APR and other costs involved in getting a new car?
- Consider the required down payment.
A 10% down payment is standard, but some lenders charge more. Go for a lender that offers a down payment that fits your budget.
- Read customer reviews online.
Quickly scan online forums and review sites to see what people say about each lender. Are interest rates high? Do people have trouble making repayments? If anything sounds sneaky, run.
- See if you’re comfortable with the payment policies.
Find out if you’ll be able to repay your car loan early without penalty or if you can make additional payments without being charged a fee. These features can save you money if you plan on paying the loan off ahead of time.
- Learn about additional services offered.
Some lenders hold your hand throughout the process of getting financing, and others don’t. Consider the help if you don’t know what you’re doing — but also ask: Is the lender genuinely helpful or just pushing you into partners’ laps. If information isn’t available online, it’s worth calling a customer service representative to get a ballpark answer.
4 red flags to watch out for
Lenders or dealerships advertising any of these four “perks” should ring the alarm bells — or at least prompt deeper research.
- There’s no credit check. Dealerships often don’t run a credit check for buy-here-pay-here loans, but these loans can cost more than one from a reputable lender. Direct lenders advertising no credit check, however, could be a scam.
- It lets you take your car home before approval. This could be the sign of a “spot delivery scam,” where a dealer calls a few days later to announce that financing fell through and you now need to renegotiate your loan at a much higher price.
- It lies about your credit score. Some dealerships con borrowers into paying higher interest by telling them their credit score is worse than it actually is. Yet another reason to check your credit report before comparing lenders.
- It offers 0% financing. You may not pay an APR on your car loan, but you typically aren’t able to negotiate your car’s price or take advantage of rebates. Loan terms also tend to be shorter, sometimes unaffordably so.
How do I apply for a car loan?
The car loan application process can vary depending on the type of financing you choose. Starting the process online with a bank or online lender involves more steps, but you have the advantage of getting preapproved for the loan and taking that offer to multiple dealerships. Although starting at the dealership is quicker, you lose some negotiating power.
LEARN MORE: How to get a car loan in 7 steps
What happens during the application process
Before you apply, check that you know these 6 pieces of information …
- How much you can afford for a down payment
- How much you want to pay each month
- Your state’s required taxes and fees
- Your credit score
- Which vehicle you want to buy
- The lender’s eligibility requirements
Have these three documents handy …
- Your driver’s license
- Your insurance card
- Employment verification — tax returns or recent pay stubs
I got my car loan. What happens next?
So, you’ve finalized the deal that got you behind the driver’s seat. Now it’s time to start paying off your car loan. If it’s an option with your lender, set up autopay to save time — and memory space — you would spend making manual repayments each month. Some lenders even offer a discount off your interest rate for signing up for automatic repayments.
Keep track of your personal account and loan balance to make sure everything’s going smoothly — sometimes even automated systems make mistakes. Contact customer service if you notice anything off.
Didn’t get the loan? Find out why your application was rejected.
Prepaying your car loan: What you need to know
With many loans, you can save on interest by paying off your balance early. This isn’t always the case with car loans, however. Some lenders charge prepayment penalties, while others give you a precomputed interest rate using what is known as the Rule of 78 formula. These loans frontload interest so that borrowers pay around two-thirds of their loan’s interest in the first few months.
In both of these cases, you don’t stand to save much by paying off your loan early. You can still lower your debt-to-income (DTI) ratio, however, which can help you qualify for other forms of financing.
Even if there isn’t a prepayment penalty and your loan comes wth simple interest, be sure to call your lender to ask if there’s a special process for paying off your loan early. Also ask if extra repayments go toward the principal — not interest. Otherwise, making extra repayments might not make much of a difference.
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