What is a car loan and how does it work

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

What is a car loan

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

Lenders generally require borrowers to have a good or excellent credit rating to qualify for 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 qualify for a lower interest rate, which could save you money over time.

How auto loans work

Car loans come in many varieties, including dealer financing, car loans from banks or credit unions, and loans from online lenders. The type of loan that is best for you depends on factors such as 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 shop and finance in one place. The dealership will likely check your credit. If you have a good credit rating, you may be eligible for a manufacturer’s promotional rate if you go through a certified dealer.

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.

Car loan from a bank or credit union

You can also apply for a car loan from a traditional bank or credit union. These loans are financed by the lender, so you won’t have to go through a dealership. However, it may take longer 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 make sure the lenders you are looking for offer the amount you need for your new car.

Online car loan

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

How to compare car loans

Similar to how you compare mortgages, the best way to compare auto loans is to look at key costs — including interest rate, term, and fees — along with 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, your income, and the term and amount of the loan. If you are looking for a longer term loan, expect a higher interest rate. If your credit score is higher, you will have access to better rates. The lender will also factor in additional fees, so be sure to review the loan structure.


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


Think of your car loan costs like all the other costs you pay to buy a car. The two main fees you need to look at are set-up fees and documentation fees. The origination fee is the amount you pay to secure the loan. The documentation fee will cover the lender’s costs to secure your loan.

How to get a car loan

The key to getting 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 pre-approved loan option.

1. Do your homework

Don’t wait until you’re ready to buy a car to learn more about auto loans. Start with the basics, like your credit score and your current financial situation.
This involves having a good understanding of your budget so you can get an idea of ​​what car you can afford. Check your credit reports – non-mortgage debt and delinquencies aren’t the only factors hurting your credit.

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

Discount Rate Advice: 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 pre-approved

If you’ve found a car you like and have saved some money for a down payment, you can walk into a dealership knowing exactly how much you can afford. It is also helpful to get pre-approved for a loan in advance. This involves filling out forms with banks, credit unions or online lenders to get an idea of ​​the rates they can offer you.

Discount Rate Advice: When you apply for pre-approval, you will often only have a purchase period of at least 30 days after. During this time, you can find the car that best suits your needs.

3. Shop

Once you’ve secured a loan, it’s time to shop for a car, including at the dealership. It’s a good idea to compare the prices with the figures given to you, which include the interest rate, monthly payment, loan amount and term.
Currently, it’s hard to get out with anything below the listed price, but that doesn’t mean you shouldn’t try to trade.

Discount Rate Advice: When looking at vehicles, keep an eye out for salespeople pushing you into a deal that doesn’t serve you. Never be afraid to walk away from a bad deal.

4. Do the trick

The moment you find the car you want, ask for the dealer’s finance offer and compare it to the deals you’ve already made. Avoid being rushed when signing documents and read everything you sign.

Exchange Rate Tip: Beware of add-ons you don’t need. Many times you could avoid them altogether or get them for much less outside of the dealership.

The bottom line

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

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