What An Auto Loan Is And How It Works

If you are looking to get behind the wheel of a vehicle you must first arrange for vehicle financing. An auto loan is simply money you borrow to pay for the vehicle. There are a range of options when it comes to auto loans, so it is important to understand the process in order to get the best auto loan possible.

What an auto loan is

An auto loan allows you to borrow money from a lender and use that money to purchase a car. You’ll have to repay the loan in fixed installments over a set period, and interest will be charged on the money you borrow.

Lenders typically require borrowers to have good or excellent credit scores to receive favorable interest rates. Your credit score is also a factor in determining the initial loan amount. If you have a high credit score, you may be able to qualify for a lower interest rate, which may save you money over time.

How auto loans work

Auto loans come in a few varieties, including dealer financing, car loans from banks or credit unions and loans from online lenders. The type of loan that’s best for you depends on factors like your credit score, loan amount and the vehicle you want.

Dealer financing

Dealer financing is the easiest type of loan to get since you can do your shopping and financing in one spot. The dealer will likely check your credit. If you have a strong credit score, you may qualify for a promotional rate from the manufacturer if you go through a certified dealership.

But dealer financing tends to come with a higher interest rate. This is because dealers often take a commission when they match you with financing from a bank or credit union.

Bank or credit union auto loan

You can also apply for a car loan at a traditional bank or credit union. These loans are funded by the lender, so you won’t have to go through a dealer. However, it may take more time than going through a dealership. Expect it to take at least one business day to get a loan from a bank or credit union, up to a week.

Lenders often have a minimum and maximum loan amount, so be sure the lenders you’re looking into offer the amount you need for your new car.

Online auto loan

You can also apply for an auto loan online. These loans are often processed remotely, but the steps are similar to getting a car loan from a bank or credit union. It may take as little as one business day to get approved.

How to compare auto loans

Similar to how you compare mortgages, the best way to compare auto loans is to look at the key costs — including interest rate, term and fees — along with the estimated monthly payment.

Interest rate

The interest rate is one of the most important numbers when deciding on a loan. The rate is based on your credit score, income and the term and amount of the loan. If you’re in the market for a longer-term loan, expect a higher interest rate. If your credit score is higher, you’ll have access to better rates. The lender will also factor in additional fees, so make sure you review the structure of the loan.


Just as you’d expect with any loan, there will be a set number of months included in the term of the loan. If you plan to purchase a new car and keep it for a long time, you’ll be able to lock in a lower monthly payment by taking out a longer-term loan — but you’ll pay more interest over time. To save that money, take out a shorter term. Just make sure the payments are well within your budget.


Think of your auto loan fees like any other fees you pay for the purchase of a car. The two main fees you need to review include the origination fee and the documentation fee. The origination fee is the amount you pay to secure the loan. The documentation fee will cover the lender’s costs for securing your loan.

How to get an auto loan

The key to securing an auto loan is to be prepared with your finances and to shop around for rates. You should also go to a dealership with a preapproved loan option.

1. Do your homework

Don’t wait until you’re ready to buy a car to learn about auto loans. Start with the basics, such as what your credit score is and what your current financial situation looks like.
That includes having a good understanding of your budget so you can get a sense for what car you can afford. Check your credit reports — non-mortgage debts and delinquencies are not the only factors that hurt your credit.

You should also research the average interest rate and monthly payments on different car makes and models. Think about how long you plan to keep your car and whether you can afford new or used.

Bankrate tip: Use an online auto loan calculator to estimate your monthly payments and available interest rates based on the car you’re considering and your credit profile.

2. Get preapproved

If you’ve found a car you like and have the money saved for a down payment, you can go to a dealership knowing exactly how much you can afford. It also helps to get preapproved for a loan ahead of time. This involves filling out forms with banks, credit unions or online lenders to get an idea of the rates they can offer you.

Bankrate tip: When you apply for preapproval, you will often only have a shopping period of at least 30 days after. During that time, you can find the car that best fits your needs.

3. Shop around

Once you’ve secured a loan, it’s time to shop around for a car, including at the dealership. It’s a good idea to comparison shop with the numbers you’ve been given, which include the interest rate, monthly payment, amount and loan term.
Currently, it’s difficult to get out with anything below the sticker price, but that doesn’t mean you shouldn’t try to negotiate.

Bankrate tip: As you look at vehicles, keep an eye out for salespeople who pressure you to make a deal that doesn’t serve you. Never be afraid to walk away from a bad deal.

4. Make the deal

The moment you find the car you want, ask for the dealer’s financing offer and compare it to the deals you’ve already locked down. Avoid being rushed when you’re signing paperwork and read everything you sign.

Bankrate tip: Beware of dealer add-ons you don’t need. Many times, you could avoid them altogether or get them for much less outside the dealership.

The bottom line

Simply, a car loan is an agreement between the lender and you, the borrower, that allows you to borrow money to purchase a vehicle over an agreed-upon term. While the process of getting a car loan can be more complex than getting a personal loan, it is still possible to do it yourself and get a good deal.

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