Everything You Need to Know About Auto Loans

Major life purchases like houses and cars are a hallmark of adulthood. But they also come with a major price tag. Unless you have enough cash to comfortably buy your car outright, you’ll need to understand how to finance a car. 

Financing a car refers to how you’re paying for it. Leasing is a way to finance a car, but this most often refers to an auto loan. Rising interest rates have made purchasing cars — both new and used — more difficult for most shoppers. But most people need a car to live. So almost 40% of used car buyers and 80% of new car buyers use some sort of financing to cover the purchase of their car, according to Statista. 

Just like with other loans, you need to understand what you’re signing up for to keep your financial well-being in check. We’re going to walk you through everything you need to know about auto loans, from the different types to how to apply for one to how to manage it once you have to start paying. 

What is an Auto Loan? 

An auto loan is a sum of money that you borrow from a lender to buy a car. You’ll pay fixed monthly payments for the duration of the loan. It will include interest and fees. Your credit score helps determine your interest rate and the amount of money you can borrow. 

Shoppers take out a loan because they can’t, or don’t want to, pay the entire cost of the car upfront. The average cost of a used car in the U.S. in 2024 is $24,735. Most of us don’t have that in the bank. 

Even if you don’t need financing for the full cost of a car, you can pay cash for part of it and get a smaller loan for the rest.   

How Auto Loans Work

When you get an auto loan, you’ll be set up to make regular monthly payments for a fixed amount for the length of the loan. You’ll also be charged interest on the loan, which should be a good incentive to pay it off as quickly as possible.

If you fail to make car payments, the lender or bank that gave you the loan can seize your car.

The interest on your car loan is called the APR (annual percentage rate). While it doesn’t sound like a big difference to have 8% versus 6%, over the life of your loan, it could cost you thousands more. You’ll have a more favorable APR if you have a high credit score or choose shorter terms for your loan (four years vs. six years).  

Types of Auto Loans

There are three paths you can take on your quest for a new (or new to you) car. 

• Bank or credit union auto loans: Talk to your bank or local credit union about their offers for car loans. Because you are going straight to the lender (the bank), you might find the best interest rates here. However, plan ahead because you might need a couple of days to get approved and funded for a car loan.
• Dealership loans: If you prefer one-stop shopping, most car dealerships also offer financing. They will pull your credit score, but if your credit is high enough, you might qualify for special deals or interest rates. Because you’re financing through the dealer and they take a cut, you might run into higher rates than your bank. 
• Online loans: You can do anything online, including getting a car loan. Online lenders will have a similar process to applying for a loan through the dealership or your bank. The good news is they might be able to work with you if your credit isn’t where you want it to be. 

Now let’s say you bought a car when interest rates were high, but now rates are dropping, and you’re wondering if you can get a piece of the action. You actually can. 

• Refinancing Loan: This means you’re transferring the balance of your loan to another lender to get a lower interest rate. Refinancing only makes sense in certain circumstances, and you have to make sure your vehicle qualifies under the lender’s requirements. It might be a good idea if your monthly payment is too high, you’ve improved your credit score or you financed through the dealership and you’ve found better rates elsewhere. Refinancing can also have downsides, like additional fees and interest.

What Does It Mean to Finance a Car?

Financing a car refers to how you pay for it — in this instance with an auto loan. A lender offers to pay the balance for the car while you agree to pay them back, plus interest and fees. Until the loan is paid back in full, your car is collateral for the loan. 

How to Finance a Car

Ready to pull the trigger on a new set of wheels? Here’s how you can start the process of financing your next car with an auto loan. 

To make shopping easier, stop by your bank to learn more about how much you qualify for. If you only qualify for a $15,000 loan, you can stop scoping out $50,000 trucks. You can also use an auto loan calculator to help you with your budget. Even if you qualify for a large amount, it is very important to have a manageable monthly payment. 

Once you’ve decided on a loan type, you’ll need to fill out the application, which will ask for bank statements or proof of income and identification. 

After you are approved for the loan, the lender will dispense the funds so you can go to the seller of the car and pay for it. 

What is a Car Note?

A car note is also known as a car payment. It will outline your monthly payments, including fees and interest. The more cash you put down at the time of purchase, the lower your car note payment will be. If you fail to make payments, you can get hit with late fees, or the lender could take your car.

How to Apply for an Auto Loan

The first steps depend on whether you want a car dealership to arrange the financing or you want to take it on yourself. If you go through a dealership after finding a car, you apply for the loan with them and they give your information to lenders. They’ll then provide you with a quote once a lender agrees to finance your vehicle. This can all likely be done on the same day.

If you’re going to shop for a loan yourself, you’ll start with getting pre-approved by a bank or credit union. You’ll get a loan quote that tells you the interest rate and the loan length, which factor how much your payment will be each month. Use this information to compare offers from lenders and get the best rate. 

For either scenario, these factors affect if you get approved:

• A good credit score (around 675 or higher)
• Your credit history
• Other debts
• Your income

If you have time before you need to buy a car, work on improving your credit score and save up more for the down payment. If you need it right away, compare as many quotes as you can or consider asking someone to be a co-signer. But make sure they understand that they’ll be responsible for making payments if you can’t. 

Factors to Consider When Financing a Car

Anytime you agree to a loan of this size, you want to make sure you’ve done your research before you sign all the paperwork. Ask yourself some of the following questions to make sure you are confident in your financing decisions:

• How much cash do I have for a down payment? 
• Did I shop around for the lowest interest rate? 
• Will my monthly payment be manageable? Including occasional car repairs and maintenance?
• How quickly can I pay off the loan? What loan terms are best for me?
• Can I improve my credit score before applying for a loan? 
• Have I included insurance in my monthly car budget? 

Managing Your Auto Loan

It’s an exciting moment once you have the keys in hand. Now, you can get into a rhythm for paying back your auto loan. If you haven’t started a budget, now is the time. Use apps like Quicken Simplifi to see how you’ll need to adjust your spending to accommodate your new monthly payment.

Just because you agree to a 36-month term loan doesn’t mean that you have to wait that long to be debt-free. You can pay additional money toward the principal (loan balance before interest) balance on your loan to pay it off sooner and save yourself money on interest. 

As mentioned above, there may be circumstances where refinancing your loan makes sense. Talk to your lender about the qualifications for auto refinancing and if you are a good candidate for negotiating a lower interest rate. 

If loan payments become something you can no longer afford, don’t just stop making payments. This means you’re defaulting on your loan. The lender likely will take your car and your credit score will take a hit. You could even face legal action if the debt goes to collections. Talk with your lender about your options. They may have programs for emergency circumstances.

FAQs About Auto Loans