Guide To Auto Loans
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There’s a lot to consider when you take out an auto loan. Whether you’re leasing, purchasing, or refinancing a car, we can help you navigate the process and understand the terms used in the industry. We created this guide to auto loans to help you learn the ins and out of financing a car.
We’ll explain industry terms, what affects interest rates, and how to get the best auto loan rates.
How Do Auto Loans Work?
Auto loans are usually secured loans, meaning they typically use the car that’s being financed as collateral. This is why car loans generally have much lower interest rates than personal loans and credit cards.
Auto loan terms can range from 12 to 84 months and sometimes be even longer. Most experts warn against 84-month auto loans. While their low monthly payments may seem attractive, they often have higher interest rates and cost more overall.
The total cost of borrowing is usually known as the annual percentage rate (APR), which combines a loan’s interest rate with any fees or discounts that apply. Some lenders offer loans with rates as low as 0 percent–but only for buyers with excellent credit.
The lowest rates most car buyers will see—even if they have excellent credit—is around 3 percent. According to Experian’s State of the Auto Finance Market Q3 2022 report, the average car loan rate is 5.16 percent for new cars and 9.34 percent for used vehicles. That’s up from the third quarter of 2021, when rates averaged 4.09 percent for new cars and 8.12 percent for used cars, according to the report.
Common Types Of Auto Loans
Borrowers have different needs and financial situations, so many lenders offer a variety of financing options.
Purchase Loans
As the name suggests, a purchase loan is designed for buying a vehicle. There are three types of loans within this category: new car, used car, and private party.
New Car Purchase Loan
A new car loan is used to buy a new vehicle from a licensed dealer. These loans typically come with lower rates than used car loans and private party loans.
Used Car Purchase Loan
A used car loan is for buying a used vehicle from a licensed dealer. The interest rates on used car loans are often higher than those on new car loans because of used vehicles’ depreciation.
Private Party Loan
A private party loan is used to buy a vehicle from a private seller. Private party financing is usually harder to come by because many lenders see it as riskier than new or used car financing.
Lease Loans
An auto lease is a rental agreement between you and a leasing company. These agreements usually last between 12 and 36 months and have set monthly payments. Sometimes, once the lease contract expires, you have the option to purchase the car. If you opt to buy your leased vehicle, you can finance the purchase with a lease buyout loan.
Refinancing Loans
A refinancing car loan replaces your existing loan with a new one. Most people refinance to save money, often through reducing their interest rates or lowering their monthly payments by extending their loan terms. Refinancing may also allow borrowers to choose shorter loan terms, which helps them save money on interest.
There are two main types of refinance loans: standard and cash-out.
Standard Refinance
A standard refinance loan pays your current loan off, ideally reducing your interest rate and helping you spend less on your car overall. Securing a lower refinance auto loan rate will reduce the total interest you pay, as will taking on higher monthly payments for a shorter term.
You can reduce your monthly payments by extending your loan term, but that would increase the amount of interest you pay overall.
Cash-Out Refinance
A cash-out refinance loan allows you to borrow against the equity in your car. This will increase your loan-to-value ratio, which is the amount you owe divided by your car’s value. Cash-out refinance loans usually extend your loan term.
Where To Find Auto Loans
Because auto loans are such popular financial products, you can secure them from a variety of institutions. There are pros and cons to each lending option depending on your needs.
Banks
Brick-and-mortar banks tend to offer discounts to customers who currently have checking, savings, or other types of accounts with them. Traditional banks where customers can meet lenders face-to-face typically offer competitive rates, though some have stricter lending requirements than other financial institutions.
Credit Unions
Credit unions are member-owned, meaning they’re not run for profit. So they’ll often offer lower interest rates and have less strict lending requirements than banks. Membership requirements differ depending on the credit union, but they often involve a nominal fee or charitable contribution.
Car Dealerships
Many car dealerships have in-house financing options that often have interest rates lower than those of banks or credit unions. Larger brand dealerships sometimes offer 0 percent APR deals for drivers who have good credit and low debt-to-income (DTI) ratios or make large down payments.
There are also independent car dealerships that offer vehicle loans to drivers with bad credit. Sometimes called “buy here, pay here” (BHPH) dealerships, these businesses often charge incredibly high interest rates. Some BHPH dealerships install tracking devices on vehicles they finance so they can easily repossess cars from drivers who default on their loans.
Online Lenders
Online lenders provide an alternative to traditional auto financing, making it easy to compare loan options. Plus, applying online simplifies the process, often leading to approval and offers within minutes.
Some online lenders are direct lenders or backed by large banks, while others are lending brokers. There are also loan marketplaces that allow you to post your lending needs online. Lenders then review your information and send offers directly to you.
Auto Loan Rates
It’s important to understand the terms lenders use before you choose an auto loan. You’ll be better equipped to find the right car loan if you know what common lending terms mean, how to calculate loan costs, and how your finances affect the rates lenders offer you.
Interest Rates Vs. APRs
The terms “interest rate” and “APR” sometimes get used interchangeably, but they’re different things. The interest rate refers to the percentage the lender charges you to borrow money. The APR factors any fees or discounts into the interest rate. The APR is what you’ll most commonly see advertised. You can get a better sense of what you’re likely to pay by looking at the APR.
Common Auto Loan Costs And Fees
These are the most common types of auto loan fees you’ll see, though how much lenders charge for each will vary:
- Application fee: Some lenders charge potential borrowers a flat fee for submitting loan applications.
- Origination fee: A lender may charge a fee for processing a loan. Depending on the company, it can be a flat fee or a percentage of the loan amount.
- Payment-related fees: Some lenders charge fees for the method you choose to make your loan payments. Online or credit card payments may come with processing fees. Some companies also charge fees for late payments or returned payments.
- Prepayment penalty: Your lender may charge you a fee if you pay your car loan off before the end of the term. This charge is meant to help the lender make up for some of the interest you would have paid on your loan.
Factors That Affect Auto Loan Rates
Interest rates vary from person to person and lender to lender. When you apply for auto loans, lenders look at the following metrics to determine your rates:
- Debt-to-income ratio: Your DTI ratio is calculated by dividing the total amount of your monthly debt payments by your gross monthly income. If your DTI ratio increases, you’ll likely be offered higher interest rates. If your DTI ratio is 43 percent or higher, it may be more difficult to get loan approval.
- Vehicle details: The make, model, model year, and mileage of the car you want to finance all factor into the rate you’ll pay. Lenders typically charge higher rates for older or higher-mileage vehicles.
- Loan term: While longer loan terms come with lower monthly payments, they tend to have higher interest rates. Loan terms can extend up to 84 months. Some last even longer.
- Credit history: Borrowers with good credit scores have an easier time securing lower APRs. Borrowers with poor credit scores tend to see much higher rates. Any missed payments or delinquent accounts can lead to higher interest rates.
- Federal funds rate: The federal funds rate–commonly referred to as “the interest rate”–is the rate at which financial institutions borrow money from one another. If the interest rate increases, lenders’ rates for car loans will likely go up as well.
- Market rates: Lenders take their competitors’ rates into account when determining their own.
How Does My Credit Score Affect My Auto Loan Interest Rates?
Your credit score is perhaps the biggest factor in calculating your auto loan interest rate. Lenders use a customer’s credit score to determine their creditworthiness–how likely they are to repay their loan on time and in full. Borrowers with excellent credit can secure low APRs, while those with poor credit may only have access to loans with high interest rates.
The table below shows the average car loan interest rate by credit score, according to the most recent edition of Experian’s State of the Automotive Finance Market report.
| Credit Score Range | Average Loan Rate for New Car Purchase | Average Loan Rate for Used Car Purchase |
|---|---|---|
| 781–850 | 3.84% | 3.69% |
| 661–780 | 4.90% | 5.47% |
| 601–660 | 7.25% | 9.81% |
| 501–600 | 10.11% | 15.86% |
| 300–500 | 12.93% | 19.81% |
Credit Scoring Models
There are two main credit scoring models: FICO® and VantageScore. Most lenders use FICO scores to evaluate borrowers, but others use VantageScore. Both scoring systems give scores between 300 and 850, which classifies borrowers according to the credit bands listed in the table below.
| Credit Score Provider | Credit Score Range | Credit Score Category |
| FICO | 300–579 580–669 670–739 740–799 800–850 |
Poor Fair Good Very Good Exceptional |
| VantageScore | 300–499 500–600 601–660 661–780 781–850 |
Very Poor Poor Fair Good Excellent |
Factors That Affect Your Credit Score
There are five factors that make up your FICO credit score, and each is weighted differently.
- Length of credit history (15 percent): The longer your history of on-time payments, the higher your credit score will be.
- Credit mix (10 percent): People with higher credit scores generally have a diverse mix of credit and loan accounts. These may include credit cards or other lines of credit, personal loans, and mortgages.
- New credit (10 percent): A hard inquiry, sometimes called a hard pull, is when a lender checks your credit during the application process. Hard inquiries briefly hurt your credit score. However, most credit scoring models have a window of 14 to 45 days during which inquiries for the same kind of credit–like a car loan–only count as one hard inquiry.
- Amounts owed (30 percent): Experts advise using no more than 30 percent of your available credit. Using too much of your available credit can hurt your credit score.
- Payment history (35 percent): Late or missed payments on your credit report can make your credit score drop.
What To Know When Shopping For An Auto Loan
While you can still walk into a bank, credit union, or dealership to apply for an auto loan, there are also options available online. No matter how you apply for auto financing, this section of our guide to auto loans can help you as you shop.
Understanding Your Auto Loan Budget
You should begin any auto loan application process with clear knowledge of your budget. Experts caution against spending more than 20 percent of your take-home pay on your vehicle. If you can manage it, keeping your car expenses to 10 percent of your take-home pay is ideal.
In addition to loan payments, gas, maintenance, insurance, and other car expenses all factor into that calculation. If, for example, you take home $2,800 per month, keeping your monthly car expenses to about $280 is a good goal.
How To Use An Auto Loan Calculator
Many lenders offer auto loan calculators to help you determine how much of a loan you can afford. These tools can help you budget by using different down payment amounts, loan terms, and interest rates to show what you’d pay in interest. Some loan calculators can estimate your interest rate based on your credit score.
Preapproval Vs. Prequalification
Preapproval and prequalification seem like similar concepts, but it’s important to learn the distinction between the two.
Preapproval happens when you apply for financing and the lender then does a hard credit pull and offers you an auto loan. Because preapproval requires a hard inquiry, it will temporarily hurt your credit score. However, being preapproved makes you look like a cash buyer, which gives you more leverage when negotiating with a dealer.
Prequalification is simply a financial institution’s estimate of the loan amount you might qualify for. Because you wouldn’t have applied for a loan yet, prequalification only uses a soft pull, which doesn’t affect your credit score. Being prequalified can help you plan your budget. It’s not a loan offer.
How To Compare Auto Loans
As with shopping for car insurance or an extended car warranty, it’s a good idea to compare loan offers before accepting one. If you apply for multiple loans within a short time period, your credit score won’t suffer too much. Once you’re committed to financing a car, compare several loans to find the right fit.
When comparing auto loans, look through all of the fine print and disclosures for the following information:
- Late or missed payment fees: If you pay late or miss a payment, some lenders will charge you a flat fee or a percentage of the monthly payment.
- Ease of use: When you sign a loan contract, you’re also entering into a months- or years-long relationship with a lender. Some lenders make it easier than others to pay your bill and manage your account online or with a mobile app.
- Required insurance coverage: Some lenders require you to carry collision insurance, comprehensive insurance, and guaranteed asset protection, also known as gap insurance.
- Prepayment penalties: Lenders make their money from the interest on monthly loan payments, so they may charge a fee if you pay your loan off early.
How To Get The Best Auto Loan Rate
Aside from comparison shopping, here are some strategies for getting the best rate on an auto loan:
- Get a co-signer: If you don’t have a stellar credit score, find a family member or friend with excellent credit to co-sign your loan. Make sure you can make the payments, however, as missed or late payments will affect both your and your co-signer’s credit scores.
- Make a larger down payment: If you can afford it, make a sizable down payment. Putting up more cash or a trade-in can get you a lower APR and lower monthly payment.
- Use autopay: Your lender may offer a discount to customers who set up automatic payments.
- Choose a shorter loan term: Selecting a shorter term will increase your monthly payment, but you’ll pay less interest over the life of the loan.
- Choose a new car over a used one: Lenders tend to offer lower interest rates on new cars. So if you’re looking at new and used versions of the same model, consider the new car over the used one.
Guide To Auto Loans: FAQ
Below are frequently asked questions about auto loans.
What should you consider when getting an auto loan?
When getting an auto loan, you should consider your budget and credit score, as well as the annual percentage rate and contract terms each lender offers. While choosing a longer loan term would get you lower monthly payments, you would pay more in interest.
Is 72 months good for a car loan?
No, 72 months isn’t the best option for an auto loan. A longer loan term generally comes with a higher interest rate, and spreading loan payments over more months costs more in interest.
Is it better to get an auto loan from your bank or the dealership?
It may be better to get an auto loan from your bank or credit union because it would likely offer you lower interest rates than dealerships would.
Is it good to pay a car loan off early?
Paying your car loan off early saves you money on interest. But some lenders may penalize you for it. Lenders make money from the interest on your car payments, so some charge a prepayment penalty to make up for lost interest income.
Can you negotiate APR on a car loan?
Yes, much like the purchase price of a vehicle, APRs are generally negotiable. The APR initially offered may not be the lowest you qualify for.
What credit score do you need to get 0 percent financing on a car?
To get 0 percent financing on a car, you’ll typically need a credit score of 740 or above. These requirements differ from lender to lender.
*Data accurate at time of publication
