An auto loan lets you pay for a vehicle over time. You borrow money from a lender, then repay it in fixed monthly payments that include interest. Understanding a few key terms makes it much easier to compare offers and see what a car will really cost.
The key terms
Principal: the amount you borrow. It's usually the vehicle price, plus any taxes and fees you choose to finance, minus your down payment and trade-in value.
Interest rate and APR: the interest rate is the cost of borrowing. The annual percentage rate (APR) includes the interest rate plus certain lender fees, so it's the better number for comparing offers.
Loan term: how long you have to repay, often between 36 and 84 months.
Monthly payment: the fixed amount you pay each month, set by the principal, APR and term.
Total cost: everything you pay over the life of the loan, including interest, plus your down payment.
How your payment is calculated
Most auto loans are simple interest, amortizing loans. Each payment covers that month's interest first, and the rest reduces your principal. Early payments go more toward interest; later payments go mostly toward principal.
Because interest is charged on the remaining balance, paying extra toward principal can reduce the total interest you pay. Check your loan agreement first, as some loans have prepayment terms.
How the loan term changes the cost
A longer term lowers your monthly payment but increases the total interest. Here's an example for a $25,000 loan at 7.5% APR:
Term | Monthly payment | Total interest | Total repaid |
|---|---|---|---|
36 months | $778 | $2,996 | $27,996 |
48 months | $604 | $4,015 | $29,015 |
60 months | $501 | $5,057 | $30,057 |
72 months | $432 | $6,122 | $31,122 |
84 months | $383 | $7,210 | $32,210 |
In this example, stretching from 48 to 84 months lowers the payment by about $220 a month but adds about $3,200 in interest. Longer loans can also leave you owing more than the car is worth for longer, which matters if you sell it or it's totaled. Figures are rounded and exclude taxes and fees; your actual APR depends on the lender and your credit.
Down payment and trade-in
A larger down payment or trade-in reduces how much you borrow, which lowers both your payment and your total interest. It can also help you avoid owing more than the car is worth early in the loan.
If you still owe money on your trade-in, the remaining balance may be added to your new loan. This is called negative equity, and it increases the amount you borrow.
Getting a loan: preapproval vs dealer financing
Preapproval from a bank, credit union or online lender tells you the APR and amount you qualify for before you shop. It gives you a benchmark to compare against.
Dealer financing is arranged at the dealership with one of the lenders it works with. It can be convenient and sometimes includes promotional rates, but the rate you're offered may include a markup, so compare it against your preapproval.
Rate shopping within a short period is generally treated as a single inquiry by common credit scoring models, so comparing several lenders usually has a limited effect on your credit score.
Tips before you sign
Compare by APR and total cost, not just the monthly payment.
Negotiate the vehicle price separately from the financing.
Read the contract for add-ons such as extended warranties or service plans, and decide whether you want them.
Budget for insurance, since lenders usually require collision and comprehensive coverage. See Liability vs Full Coverage.
To estimate your own payment and total interest, try our Car Loan Calculator.
Frequently asked questions
What's the difference between interest rate and APR?
The interest rate is the cost of borrowing the principal. APR includes the interest rate plus certain fees, expressed as a yearly rate, which makes it more useful for comparing loan offers.
Is a longer auto loan a bad idea?
Not always, but it usually costs more in total interest and keeps you owing more than the car is worth for longer. A longer term can make sense if you need a lower payment, as long as you understand the extra cost.
Can I pay off my car loan early?
Usually, yes. With a simple interest loan, paying early typically reduces the total interest you pay. Check your loan agreement for any prepayment terms first.
