Learn How Car Loan Works

Purchasing a new or used car may be one of the most significant expenditures you make in your life. However, with all of the moving pieces that come with a car loan, determining how to pay for your ride can send you into a tailspin.


According to a Consumer Financial Protection Bureau blog post published in 2018, the average price of a new automobile is roughly $35,000, so you’ll almost certainly need to take out a car loan.

But, before you go out and buy your new set of wheels, it’s a good idea to conduct some research on auto loans. This post will look at the most popular forms of automobile loans, auto loan lenders, crucial phrases to understand, and how to prepare to apply.

What exactly is a car loan?

When you don’t have the cash to buy a new automobile outright, a car loan can help you do so – whether the vehicle is new or used. When you obtain an auto loan, you borrow money from a lender to purchase an automobile. You promise to repay the cash plus any fees and interest accrued over a specified period.

Important concepts to understand

Before we get into the specifics of how vehicle loans work, let’s take a moment to familiarize ourselves with some of the most popular terminologies you may come across while you research loan choices.


Annual percentage rate (APR) – The annual percentage rate (APR) is the amount you’ll pay to borrow money, including interest and fees, expressed as a yearly percentage. The greater the APR, the more you will owe in exchange for the loan.

  • Down payment – This is an upfront payment made toward purchasing the car. It might be cash, the value of a trade-in vehicle, or both. The down payment reduces the total amount you need to finance, resulting in reduced monthly payments.
  • Loan period – Also known as loan duration, this is the amount of time you have to repay your loan. Keep in mind that the longer your loan period, the more interest you’re going to pay.
  • Monthly payment – The amount you owe each month is your monthly payment. It comprises principal, interest, and any extra costs that may apply.
  • The principal is borrowed with fewer fees, penalties, interest, and other expenditures.
  • Total cost — Total cost refers to the total loan amount, or total principal and interest, that you will pay during the life of your auto loan.

What is the procedure for obtaining a car loan?

Loan payments are made to the lender every month on a car loan. Your monthly payment will be determined by the loan amount, the loan period, and the amount of interest you must pay throughout the life of the loan.

Your loan contract specifies the loan’s principal and interest rate, as well as any optional add-ons.

Longer-term loans can reduce your monthly costs, such as 60-month or 72-month loans. However, keep in mind that if you have a longer loan term, you may pay more in interest throughout the life of the loan. You can even end yourself paying more than the automobile is worth, putting you in default on your loan.

Let’s look at two potential loan conditions for a $20,000 loan with a 3.75 percent interest rate. Keep in mind that this computation excludes any relevant sales tax.

Though the longer loan term decreases your monthly out-of-pocket expenditures, if you choose to repay the loan in five years rather than three, you’ll wind up paying $788 more in interest over the life of the loan.

Loans that are most commonly used.

A car loan can be used to buy a new or used automobile. You can also apply for a loan to purchase a lease or refinance an existing loan. New-vehicle loans may have lower interest rates than used-car loans and may come with special incentives.

Where should I apply for a car loan?

When it comes to auto financing, it’s a good idea to shop around for the best offer possible. You can examine conditions from several lenders, such as banks, credit unions, and other financial organizations, to determine whether their offers are better than your dealer’s.