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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.

Auto loan rates

The average car loan rate is 5.15% APR, according to a 2020 study by Experian. But the rate you get can vary depending on your credit. The average rate for people with a credit score above 780 is 3.24% APR. But those with a 500 score got an average rate of 13.97% APR.

Some dealerships offer 0% APR introductory rates to move cars off the lot. Usually, this lasts for about a year before the regular interest rate kicks in. But usually you need a credit score of 670 or higher to qualify for these kinds of deals.

Other factors like the type of car you buy and loan term you select can influence your rate. Generally, new cars and short terms get the lowest rates. Used cars from private sellers tend to land the highest rates.

What to know before you apply

Here’s the information you should have about your finances, the lender and the car loan you’re considering before you apply.

Your budget

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.

Not all lenders require a down payment. But experts recommend that you put down at least 10%.

Rates and fees

Compare the rates and fees available with multiple providers. Your loan’s APR is interest and fees expressed as a percentage and is the easiest number to compare. But it’s useful to look at them separately, since they can increase your loan balance or the upfront cost of your loan. Some lenders charge an origination fee of 1% to 5% of the loan amount.

Terms

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.

Available rebates

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.

Preapproval

Many lenders allow you to lock in rates and terms for a car loan so you can use it to shop around at dealerships as a cash buyer. If this is available, ask how long your offer is good for. Typically a preapproval offer is good for 30 to 60 days.

Lender repayment 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.

Customer reviews

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.

Additional services

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.

Where to 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 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.

Frequently asked questions

Answers to common questions about financing a new vehicle.

How easy is it to get a car loan?

How easy it is to qualify for a car loan depends on several factors. These include your creditworthiness, income and how much you can afford to pay for a down payment. If you have strong credit and enough disposable income to afford a down payment plus monthly repayments, getting approved isn’t difficult.

The state of the economy can also affect how easy it is to get a car loan. If the economy is doing poorly and you work in an industry that’s experiencing a lot of layoffs, lenders might be more cautious about offering you a car loan. On the flip side, if the economy is doing well, lenders are typically less concerned about you losing your job and could be more willing to approve you with favorable rates.

Will shopping for a car loan affect my credit score?

Credit scoring systems usually count multiple auto loan inquiries within a certain timeframe — typically two weeks — as one. One inquiry may cause a small, temporary drop in your credit score. But it’s better than multiple inquiries.

What’s the loan-to-value (LTV) ratio on a car loan?

This is the value of your loan divided by the cash value of your car expressed as a percentage. For example, if you got an $8,000 car loan for a $10,000 car, the LTV would be 80%.

The LTV tells you how much of the price tag your lender will cover and how much of a down payment you’re required to make. On a car loan with an 80% LTV, you’d have to make a 20% down payment.

Should I lease my car instead of buying it?

Leasing is ideal if you want to drive a new car every two or three years – just remember you’ll never have ownership of the vehicle. Repayments will generally be lower on lease agreements, but they’re harder to get out of than just selling a car you’re financing.

Do I have to be a US citizen to apply for a loan?

No, resident or non-resident aliens can apply for loans with some banks or dealerships that offer financing.

Do I need a down payment for a car loan?

It depends on the lender you’re applying with. Some car loan providers don’t require a down payment at all, while others will ask for anywhere from 10% to 20% of your car’s sticker price up front. Typically, how large of a down payment you have to make is determined by the strength of your credit history.

LEARN MORE: Compare car loan providers that don’t require a down payment

I have bad credit. Do I need a cosigner to take out an auto loan?

Not necessarily. Some providers specialize in bad-credit car loans, though these typically come with rates in the double digits. You may also qualify for a car loan without a cosigner if other aspects of your application are strong, such as having a consistent income or large down payment saved up.

Can I refinance my auto loan?

Yes. Refinancing can offer you a better rate and lower repayments, and is an option available from many lenders such as LendingClub.