An auto loan is a type of loan typically secured by collateral — the vehicle you purchase — though some lenders offer unsecured auto loans. Auto loans can be used to buy new or used cars, refinance a current loan, buyout a lease or purchase recreational and powersport vehicles.
Auto loan lenders typically have repayment terms ranging from 36 to 84 months, though some may offer shorter or longer term limits. Keep in mind that if you default on your loan, your lender may repossess your car and your credit score will suffer.
With an auto loan, you agree to repay a lender over a set term, typically three to six years, in exchange for them paying a dealership (or a private seller) so that you can get a car. By paying interest, your total cost of borrowing is higher than the purchase price of your car, which equates to profit for the lender. How much more you pay in interest will largely depend on your credit score.
The interest rate on an auto loan is the percentage of the loan amount that you pay to the lender each year. It is the cost of borrowing money. The APR, or annual percentage rate, is also a percentage, but it includes the interest rate as well as other fees associated with the loan, such as origination fees and prepayment penalties. The APR is a better measure of the true cost of borrowing money than the interest rate alone, because it takes into account all of the fees that you will pay.
Every lender has its own approach to auto financing, but applying for a car loan commonly includes the following steps:
Having a good credit score plays a big role in receiving a lender’s best APR on a car loan. According to Experian, during Q1 2023, those with the highest credit scores were offered an average APR of 5.18% for new cars and 6.79% for used. However, those with the lowest credit scores were offered average APRs of 14.08% for new cars and 21.32% for used.
Yes, you can negotiate APR. Ask the dealer to beat the auto loan preapproval rate you got directly from an auto lender. Offering a larger down payment or getting a car loan cosigner could also help reduce the APR on your loan.
The average APR for an auto loan in the first half of 2023 was 6.58% for new cars and 11.17% for used cars. To receive a lower APR than the industry average, you’ll need a credit score of at least 781 for new cars and 661 for used cars.
Automakers, credit unions, banks and online lenders could all potentially provide a low rate, but credit unions tend to offer the lowest rates. Rate shopping for auto loans within a two-week window will not hurt your credit score any more than applying to one lender. Any drop to your credit score from a credit inquiry should be slight and temporary.
While car dealerships can offer turnkey services, they also tend to charge higher rates than banks and credit unions. If you want lower rates, consider getting preapproved with an independent lender before applying for a loan at a dealership. Then you can compare the two and choose the least expensive option.
As long as you make your monthly payments on time, car financing can help to build your credit and improve your score. Keep in mind, however, auto loans can affect your credit score negatively, too, since your lender will run a hard credit pull.
December tends to be the best time of year to buy a car because of MSRP discounts. Typically, newer models are introduced toward the end of the year, so dealers may be more likely to offer discounts on older models. July to October tends to be the worst time to purchase a car.