Everything You Need to Know About Auto Loans

For most Americans, having a car is not optional. But rising prices mean most of us can’t buy a car outright and have to finance our purchase.

And while getting an auto loan may be unavoidable, many of us are now paying a lot more for those loans, which can stretch already tight budgets. A record 1 in 5 new car shoppers committed to monthly payments of $1,000 or more in the second quarter of 2025, according to Edmunds.

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 money that you borrow from a lender to buy a car. You’ll pay fixed monthly payments for the duration of the loan that include interest and fees. The interest rate you’ll pay on an auto loan depends on a number of factors, including:

• You credit score. The higher your credit score, the better chance you have at scoring a lower interest rate.
• Age of the vehicle. Typically, the newer the car is, the lower the interest rate is.
• Length of the loan. In general, the longer the length of the loan, the higher your interest rate.

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.   

Until the loan is paid back in full, your car is collateral for the loan. For that reason, an auto loan is what’s known as “secured loan” — meaning the car is a tangible asset the lender could seize if you don’t make your payments.

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. 

Most lenders offer simple interest loans, meaning your monthly interest charge is calculated based on the amount you owe, or the principal amount. Every month, your payment covers the monthly interest charge plus a part of the principal. Because your interest charges are based on your principal, more of your money will go toward the principal and less toward interest with each monthly payment. And if you can pay off the loan early, you’ll pay even less in interest.

However, if you don’t qualify for a simple interest loan — which can happen if you have a lower credit score — a lender may offer you a precomputed interest loan. With this type of loan, you pay more in interest at the beginning, which means you’re not chipping away at the principal as fast as you would with a simple interest loan. You’ll end up paying more, even if you can pay off the loan early.

With either type of loan, 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. For example, say you need to borrow $30,000. With a five-year (60-month) auto loan, you’d pay $4,799 in interest at 6%, but you’d pay $6,498 at 8%. 

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 and fees than your bank. 
• Online loans: You can do anything online, including getting a car loan. The best 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, or your credit score has improved, and you’re wondering if you can get a better deal on your auto loan. You can: 

• Refinancing Loan: This means you’re transferring the balance of your loan to another lender to get a lower interest rate. If your current payment is too high, consider refinancing your loan with a company like Gravity Lending. Refinancing makes sense in certain circumstances, and you have to make sure your vehicle qualifies under the lender’s requirements. Remember to factor in any additional fees and interest when deciding if refinancing can save you money.

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 the contract you sign with a lender for your loan. It’s important to review it and keep it for your records, as it contains the following information:

• Original loan amount
• Interest rate
• Loan term (length)
• Monthly payment (including interest charges, principal and fees)
• Lender’s contact information

Also be sure to read the contract to find out the consequences 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, although you’ll likely end up paying more in interest and fees.

If you’re going to shop for a loan yourself, you’ll start with getting pre-approved by a bank or credit union. The quote will tell you the interest rate, monthly payment and the loan length. Use this information to compare offers from lenders and get the best rate. 

In either scenario, these factors can affect your qualification for a loan:

• Your credit score 
• 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 auto 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 Cleo, Monarch or Rocket Money 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 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. Even if you’re underwater on your car loan, you have options. You can also reach out to your lender to ask if they have programs for emergency circumstances.

FAQs About Auto Loans