How Do Car Loans Work: Everything You Need to Know

The last box in the chart shows how much it would cost if you bought a $15,000 car instead of one for $20,000. You would still have a monthly payment you could afford (less than $300) and save $2,000 in interest payments. If you’re in desperate need of a car and can’t shop around, or if your credit is terrible and you have to get a loan with high interest, you can refinance it somewhere down the line.

If you owe more on your current auto loan than the vehicle is worth—referred to as being “upside down”—then you have negative equity. In other words, if you tried to sell your vehicle, you wouldn’t be able to get what you already owe on it. For example, say you owe $10,000 on your auto loan and your vehicle is now worth $8,000. That negative equity will need to be paid off if you want to trade in your vehicle and take out an auto loan to purchase a new vehicle.

Dealership Financing

These are called captive finance companies, which account for 44.2% of auto loans and 61.2% of new car loans. They can make deals with promotions like 0% interest for a certain number of months or rebates (often called cash bonuses). However, those incentives are usually reserved for customers with excellent credit, so polish that credit score before shopping.

They’re willing to do this because the loans are secured by the vehicle. When the customer can’t afford to make payments, the dealer will repossess the car, sell it again and collect another down payment. There’s a reason only 7.6% of loans are issued by Buy Here Pay Here (BHPH) dealerships. These types of loans are in-house financing, and the house usually wins. BHPH dealers are notorious for offering high-interest loans to subprime borrowers. These dealerships have relationships with banks that allow them to provide financing but don’t issue loans themselves.

What does APR mean for a car loan?

However, a personal loan can be secured against an asset such as a vehicle or home. If a personal loan is secured, the lender can seize your asset to recover its losses if you don’t repay the loan. Hire purchase is arranged by the dealer and is often very competitive for new cars, but not so for second hand vehicles. The loan is secured against the vehicle, so it is not technically yours until the last payment is made. It is not always necessary to go with the bank your vehicle dealer suggests, you can always go to another lender if they offer better loan terms. Therefore, always do a thorough research by comparing lenders and their rates before finalizing a lender.

Keep this in mind when deciding what terms you want for your car loan. Because your interest rate can go up, your monthly payment can also go up. The longer the term of the loan, the more risky a variable rate loan can be for a borrower, because there is more time for rates to increase. A “no credit check” or “buy here, pay here”auto loan is offered by dealerships that typically finance auto loans “in-house” to borrowers with no credit or poor credit. Amortization describes the process of gradually paying off  your auto loan.

Important Terms to Remember

You can get an auto loan for new or used trucks, cars, SUVs, motorcycles, and more, as long as you qualify. If there are no prepaid finance charges involved in your loan, your APR and interest rate are the same. Your APR is higher than an interest rate when certain fees are applied.

Although prequalification and preapproval sound very similar, they are two different things. The difference is based on the lender’s commitment to providing financing for you and your level of interest in getting financing for a car loan. We highly recommend getting preapproved for an auto loan before you visit a dealership. An unsecured loan could auto loan means also be an option if you’re buying an old car or collector car that doesn’t qualify as collateral for secured financing. Lenders often have restrictions on the age and mileage for a car to serve as collateral. Bank of America, for example, will only finance cars that are 10 model years old or newer and have less than 125,000 miles on the odometer.

How Do Car Loans Work?

Understanding how car loans work, the different types, and what they mean for your pocketbook will land you in the driver’s seat of a car that suits your lifestyle and needs. Debt.org wants to help those in debt understand their finances and equip themselves with the tools to manage debt. Our information is available for free, however the services that appear on this site are provided by companies who may pay us a marketing fee when you click or sign up.

• While getting a car loan can be more complex than getting a personal loan, it is still possible to do it yourself and land a good deal.
• Interest rates on personal loans are generally fixed, but personal loans can also have variable interest rates.
• The privacy policies of CU SoCal do not apply to linked websites and you should consult the privacy disclosures on these sites for further information.
• Check your credit history from one of the three free credit reporting companies by going to AnnualCreditReport.com.
• If you don’t have to borrow as much, obviously it will cost you less.