What is a car loan and how does it work? | finder.com

What is a car loan?

Brush up on the basics before you hit the dealership.

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With new and used car prices on the rise, you’ve likely considered taking out a car loan to help you afford your new set of wheels. Knowing how they work and comparing the different options available can ensure you find the best financing option for your needs.

What is a car loan?

A car loan is a personal loan used to purchase a new or used car that’s secured by the vehicle you’re buying. If you fail to repay the loan, your car can be repossessed by the lender to recover its losses.

To qualify for a car loan with competitive rates, you need to have a steady source of income, low debt-to-income ratio and good to excellent credit. Some lenders also put restrictions on the age or mileage of the used car you’re buying.

The terms of your car loan will vary based on the lender you choose and your financial situation. Banks and credit unions tend to have stricter requirements but lower APRs, while online lenders may accept borrowers with less-than-perfect credit but charge higher interest rates.

What types of car loans are available?

There are four common types of car loans available to borrowers:

  • New car loans. Banks, credit unions and online lenders offer new car loans that allow you to purchase a vehicle directly from a dealership or manufacturer. Terms typically last from three to seven years.
  • Used car loans. Many lenders also offer used car loans for vehicles under 10 years old or with less than 100,000 miles. Get these loans from a dealership or private seller with terms typically lasting from three to six years.
  • Car loan refinancing. You could refinance your current car loan to extend your loan term or get a better interest rate — especially if your credit’s improved since first taking out the loan. Refinancing is a great way to lower your monthly repayments or pay less interest in the long run.
  • Lease buyouts. If you’ve fallen in love with your leased car, use a car loan to buy out your car lease. Not every lender offers this option, so do your research before applying with a lender.

How much can I borrow?

It varies by lender. Some might lend you up to 100% of your car’s value — including the cost of taxes and state fees. Others could limit the amount you borrow for a new car to around $50,000. For used cars, the amount you’re approved for will depend on the car’s age, mileage, condition and other factors.

How can I apply for a car loan?

Depending on the lender, you might have the option to fill out an application online, over the phone or in person at your local branch. Unlike other types of loans, most car loan providers offer preapproval that’s good for 30 to 45 days. This allows you to shop for the car you want and negotiate with the dealership or other lenders to get the best deal available to you.

You can also go the more traditional route and apply for financing at the dealership. While this is generally the more expensive option, it’s also the quickest. You simply visit the dealership, test-drive a few cars and then complete the necessary paperwork. The dealership processes your application, and you could drive off the lot the same day. Just be careful: If your contract states your financing is subject to approval, you may be called back with an adjusted loan term or rate.

What is a car loan connection service?

Rather than apply directly with a lender, a car loan connection service allows you to prequalify with multiple lenders at once. This can help you quickly compare offers to find the best deal available to you. Car loan connection services are especially useful if you have fair or bad credit, since you find out if you’re eligible for a loan at all.

How long does it take to get my car loan?

Once you’ve been preapproved and found the right car, it only takes a few minutes to receive your loan funds. The dealership will submit an official request to your lender — or process your application if you chose dealership financing. And you can generally drive off the lot in your new car the same day you sign the paperwork.

Compare car loan providers

Updated September 21st, 2019
Name Product Filter Values Minimum credit score Loan term Requirements
300
Varies by lender
Must be a US citizen with a current US address and employed full-time or have guaranteed fixed income.
Apply with a simple online application to get paired with a local auto lender. No credit and bad credit accepted.
600
Varies by lender
Fair to excellent credit, an income source, US citizen or permanent resident, 18+ years old
Find an offer and get rates from competing lenders without affecting your credit score.
300
Varies by lender
Must be employed full-time or have guaranteed fixed income of at least $1,500/month and be a current resident of the US or Canada.
Get connected with an auto lender near you, even if you have bad credit.
Good to excellent credit
2 to 7 years
Good or excellent credit, enough income or assets to afford a new loan, US citizen or permanent resident, 18+ years old
Quick car loans from $5,000 to $100,000 with competitive rates for borrowers with strong credit.
Fair or better credit
From 2 years
Car must be less than 10 years old with fewer than 120,000 miles. Current loan must have a balance between $5,000 and $55,000 and at least 24 months left in its term.
Lower your monthly car payments and save on interest through a fast and easy online application process.
510
Varies
Income of $2,000+/month, vehicle has less than 150,000 miles and is no older than 8 years, loan balance is between $10,000 and $100,000, debt-to-income ratio is less than 50%
Connect with a network of over 150 lenders to refinance your car loan.
Good to excellent credit
Varies by lender
18+ years old, good to excellent credit, US citizen
Compare multiple financing options for auto refinance, new car purchase, used car purchase and lease buy out.

Compare up to 4 providers

How do car loan repayments work?

For most car loans, you’ll make monthly repayments that cover a portion of the principal and interest that’s accrued. Loan terms typically last anywhere from three to seven years, but you may qualify for an eight-year term on a new car loan with some lenders. Just keep in mind that the longer your loan term, the more you’ll pay in interest. Use our car loan repayment calculator to strike a balance between low monthly payments and a loan term that won’t keep you in debt for longer than you plan to drive your car.

Can I pay off my car loan early?

Probably, though some lenders may charge a prepayment penalty to make up for lost interest. Check with your lender to see if there are any fees you should be aware of or if there’s a specific process for making extra repayments.

What happens if I can’t repay my car loan?

Reach out to your lender as soon as possible if you’re struggling to make repayments to discuss your options. It might be willing to work with you to create an alternate payment plan — especially if you can prove economic hardship.

If you’re unable to come to an agreement with your lender, you could face a few consequences:

  • Your car could be repossessed.
  • Your credit score could take a hit.
  • You could owe multiple fees.
  • Your lender could take you to court to recoup its losses.

Alternatives to a car loan

You have two practical alternatives to taking out a car loan:

  • Personal loan. You can use an unsecured personal loan to buy a car, though you’ll likely receive higher rates since it poses a greater risk to the lender. A personal loan is especially useful to buy an older car that has over 100,000 miles on it.
  • Cash. Paying for a car with cash is always the least expensive option. You won’t have to pay interest or fees like with a loan, but you’ll have to wait until you’ve saved up enough money.

While you could technically buy a car with a credit card, 401(k) loan or home equity loan, you risk paying high rates. And because cars lose their value as you drive, you may end up owing more on your loan than your car is worth.

Bottom line

Car loans are common today, so knowing how they work is the first step to getting a good deal. Once you’re ready to borrow, check out our guide to car loans for more information on how to compare your options.

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