Do You Know How Car Loans Work?

Given the expense of cars, especially brand new models, it’s often necessary to get a car loan to cover the costs. Here, we’ll discuss how these loans work.

How Do Car Loans Work?

When you want to buy a car, a car loan will cover the cost. After the purchase, you’ll make monthly payments to pay off the loan, which may take anywhere from three to seven years. Each month, interest will accrue on the loan as well, so part of each monthly payment will be put toward that interest. 

Typically, you’ll go through the following process to secure financing for your new car:

  • Apply for an auto loan
  • Get pre-approved
  • Find a car that fits within your pre-approved limit
  • Finalize the loan with your lender 

After your loan is approved, you’ll start making monthly payments until the vehicle is paid off.

Where To Get A Car Loan

There are multiple places to get a car loan. Some of the most common include those described below.


One common way to get a car loan is directly through the car dealership. Most new and used car dealerships have partnerships with multiple financial institutions, and they’ll act as the middleman between you and potential lenders. In some cases, a dealership may offer financing directly.

This method may be fairly convenient, but it does tend to cost more since they’ll collect a fee for performing that service.


Another common source of financing is a bank. Most people are familiar with this option, and they’ll typically go to their own bank first when securing auto financing.

It’s worth noting, however, that banks—particularly national chains—have standard policies in place on what they’re able to offer their borrowers, and they usually charge higher interest rates to turn a profit.

Credit union

Car buyers looking for competitive rates and customer service are oftentimes best served by credit unions. To secure financing through a credit union, you have to be a member, but most people qualify for membership without even realizing it.

Given that credit unions are nonprofit organizations, they may offer lower rates than banks or dealerships, and their local focus allows them to provide exceptional customer service for the length of the loan.

Components Of A Car Loan

A car loan consists of multiple parts, including the following.

Down payment

Most lenders won’t lend enough for the full cost of the vehicle. Instead, you’ll usually need to make a down payment. In most cases, a 20% down payment is recommended.

Loan term

The loan term is the length of time you’ll have to pay off the loan. On average, car loans range between 36 to 84 months. The loan amount plus total interest is divided up among the number of months to give you your monthly payment.


Your annual percentage rate, or APR, is the interest rate on the loan. The higher the interest, the more you’ll end up paying for the vehicle.

Interest rates may be fixed, staying the same for the life of the loan, or variable, fluctuating with the market, but typically start at a lower rate.

Additional components

In addition to the basic parts of a car loan, you might also have additional costs and factors, including:

  • Minor costs and fees, such as title transfer
  • GAP insurance, which covers the difference between your current loan balance and your car’s actual value if an accident occurs
  • Extended warranties
  • Additional services 

Many of these components are dependent on your lender, so it may be worth shopping around to find a good deal.

Ways To Save On Your Car Loan

Car loans have their associated expenses, particularly when it comes to interest. Some ways to save money on your car loan include:

Increasing your down payment

One way you can reduce the amount you borrow and your total interest is by making a larger down payment. The more you pay down, the less you’ll have to borrow, and the less time interest will have to accrue.

Buying well within your budget

Instead of buying up to the full amount that you’re pre-approved for, consider spending well within your limits. The less you spend on a vehicle, the easier and faster it will be to pay it off.

Improving your credit score

If you have less than average credit, it may be valuable to review your credit report. If you find any flaws, contact the credit bureau about it to get them corrected. 

Also, making other payments—such as rent, mortgage, and credit card payments—when they’re due can improve your credit over time.

Shop for the best rates

When looking for a car loan, try to get a lender who will give you the best rates. A credit union would be a very good place to start here.

Get a shorter loan term

The shorter the loan term, the higher your monthly payments will be, but it will also translate into less interest overall. As such, it’s best to get the shortest loan term that you can afford.

Pay it off early

If your lender doesn’t charge prepayment penalties, it’s to your advantage to pay it off early. Whenever you’re able, pay a little extra on your monthly payment. Doing so can reduce your balance faster and give interest less time to build up.


Finally, if you currently have a car loan and have improved your credit or financial situation, it may be worthwhile to refinance your loan. Doing so can get you a shorter term and lower interest, ultimately saving you money in the long run.

How Do Car Loans Work? Start The Process Now 

To begin the process of getting a car loan, talk to your lender. They’ll help you determine which options are best for you.

Learn About Car Loan Length