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Auto Loans

An auto loan is an installment loan used to buy a car, secured by the vehicle itself. You repay it in fixed monthly payments over a set term, commonly 36 to 72 months, and the lender holds a lien on the title until the loan is paid off. If payments stop, the lender can repossess the car. Because the loan is secured, rates are usually lower than for unsecured personal loans, and they vary with your credit score, the term, and whether the car is new or used.

On a $50,000 car with $10,000 down, a five-year loan at 5% costs $754.85 a month, and the $40,000 borrowed costs $5,290.96 in interest over the term. Sales tax of 7.25% ($3,625) and $2,800 in title, registration and other fees are paid upfront in that example; rolling them into the loan raises the payment to about $876.

Loan = Price − Rebate − Down − Trade-in + Owed (+ Tax + Fees if financed)

The monthly payment then follows the standard amortization formula, PMT = L × r ÷ [1 − (1 + r)⁻ⁿ], with r the monthly rate and n the number of months. Sales tax is applied to the price minus the trade-in value.

Dealership Financing vs. Direct Lending

There are two main ways to finance a car. With direct lending, you borrow from a bank, credit union or online lender and arrive at the dealership with a preapproval, effectively paying like a cash buyer. With dealership financing, the dealer arranges the loan through its network of lenders or the automaker's own finance arm and handles the paperwork in one place.

Getting preapproved directly first is usually the strongest position: you know your rate and budget before you negotiate, and you can ask the dealer to beat it. Dealers can earn a markup on the rate they arrange, so a quote from them may not be the best available. On the other hand, automaker finance companies sometimes offer promotional rates, as low as 0% for well-qualified buyers on selected new models, that banks cannot match. Compare offers by APR and total cost, not only the monthly payment.

Vehicle Rebates

Manufacturers often offer rebates, cash discounts that reduce the price of a new car, to move inventory. A rebate can be taken as cash or applied to the down payment. How it is taxed depends on the state: some calculate sales tax before the rebate is subtracted, others after.

Rebates are frequently offered as an alternative to low promotional financing, so you must choose one. Run both scenarios: on a $40,000 loan over five years, a 0.9% promotional rate costs about $40,922 in total payments, while taking $3,000 cash back and financing $37,000 at 5% costs about $41,894, so the low rate wins in that case. With a shorter term or a lower outside rate, the rebate can come out ahead. The cash back or low interest calculator compares them directly.

Fees

Beyond the price and sales tax, buying a car involves several fees. Government charges include title and registration fees and, in some places, an excise or property tax on vehicles. Dealers commonly charge a documentation (doc) fee for processing paperwork, which ranges from under $100 to several hundred dollars and is capped in some states, plus a destination charge for shipping a new car from the factory.

Optional add-ons such as extended warranties, service contracts, gap insurance, paint protection and window etching are often presented in the finance office. Some can be useful, but they are negotiable and frequently cheaper elsewhere. Ask for an itemized out-the-door price that lists every fee before agreeing to a deal, and decline anything you do not want.

Auto Loan Strategies

Check your credit report and score before shopping, since they largely set your rate. Get quotes from a few lenders within a short window; multiple auto loan inquiries close together are generally treated as one for scoring purposes. Negotiate the car's price separately from the financing and your trade-in, so savings in one area are not quietly offset in another.

Keep the term as short as your budget allows. Longer loans lower the payment but raise total interest: on $40,000 at 5%, a 72-month loan costs about $6,382 in interest versus $4,216 over 48 months. Long terms also make it more likely you will owe more than the car is worth, since cars lose value quickly. A down payment of around 20% on a new car, or 10% on a used one, helps avoid that situation.

Focus on the total cost rather than the monthly payment. A dealer can reach almost any payment target by stretching the term, which may cost far more overall.

Buying a Car with Cash Instead

Paying cash avoids interest entirely, keeps you from owing more than the car is worth and makes the purchase simple. You own the car outright, are free to sell it at any time and have no monthly payment afterward. If the alternative is a loan at a high rate, cash is almost always cheaper.

There are trade-offs. Draining savings can leave you without an emergency fund, and money tied up in a depreciating car is not earning a return elsewhere. When financing is available at a very low or 0% promotional rate, borrowing and keeping your cash invested can come out ahead. Paying cash also gives you no leverage to get rebates that require dealer financing. A middle path is a large down payment with a short, low-rate loan.

Trade-in Value

Trading in your current car at the dealership reduces the amount you need to borrow and, in most states, also lowers sales tax, because tax is charged on the price minus the trade-in value. That tax saving can make a trade-in competitive with selling the car yourself, which usually brings a higher price but takes more time and effort.

Research your car's value with online pricing guides and get offers from other dealers or car-buying services before negotiating. If you still owe money on the trade-in, the payoff amount is added to the new loan; when you owe more than the car is worth, that negative equity is rolled into the new loan, raising both the balance and the interest you pay.

Frequently asked questions

Sources

• CFPB – Auto loans
• FTC – Buying a New Car