How Do Car Loans Work?

A car loan is an installment loan that enables you to conveniently purchase a car. It’s a legally binding agreement between the lender and you. It stipulates that the lender will give you the funds, and you’re responsible for paying back the amount you borrowed along with interest and other charges.

A car loan can help make buying a vehicle more affordable by breaking it down into monthly payments over a long period of time. The amount of a car loan typically ranges from a few thousand dollars to $100,000 or more. Loan terms range from 24 to 84 months, depending on the lender. The amount you can borrow depends on your financial situation and the vehicle you wish to buy.

So, How Do Car Loans Work?

Payments on an auto loan will go towards your principal loan amount and the interest charged by the lender. Your interest expense will depend on the rate you qualify for. A higher credit rating typically results in a more favorable interest rate. In addition, many lenders offer lower rates to borrowers who choose shorter repayment terms.

During the repayment period, your lender will be the lien holder on your car, meaning they can repossess it if you fail to make payments. They will also hold on to your car title during this time. You will receive the title back once the lender has been discharged as a lien holder for the loan.

Note that a lower monthly payment doesn’t always equate to a lower overall debt. It will also depend on the loan term. Longer terms usually offer smaller monthly installments.

Factors that Affect How Car Loans Work, and Your Monthly Payments

Before probing deeper into car loans, it is best that we first learn the common terms you’ll encounter that will affect your monthly payments, as well as car loans, in general:

Annual Percentage Rate

The cost to borrow money, it includes the interest and other financing fees, and is usually expressed in annual percentages. Note that a higher APR means you’ll be burdened with a higher total debt.

Loan Term

This is the full length of time within which you need to repay the loan at monthly intervals. Note that while a longer term usually requires lower monthly payments, you’ll pay more in terms of total interest.

Monthly Payment

The amount you need to pay every month, it includes interest and other financing fees necessary to fully cover the debt.


This is the original loan amount net of interest, penalties, and other financing fees.

Down Payment

This is the initial amount you need to shell upfront to lower the amount you need to pay over the loan term.

Monthly Average Payment on Car Loans

According to BankRate, owners of brand new cars pay an average of $667.00 monthly, while the average monthly payment for second-hand cars is $515. From April to June, 2002, 38.22% of all car buyers financed their new car purchase. For the same period, 61.78% availed of financing for used cars.

SUVs account for a whopping 60% of the total number of loans.

Things to Weigh Before Deciding on a Car Loan

There is no question that qualifying for a car loan makes buying a car more affordable. However, potential car buyers have different financial conditions and credit ratings. Thus, the best car loan for one may not necessarily be recommended for another.

For instance, there are car buyers who can’t afford to pay high monthly payments. In this case, they need car loans with longer repayment terms as these loans usually require lower monthly payments. On the other hand, if you can afford higher monthly payments, you can opt for loans with shorter repayment terms. This way, you can pay off the loan within a shorter period.

If you already have a car loan, but you want to find a way to make your monthly payments lighter, you can explore the prospects of refinancing your loan. An online refinancing calculator would help determine the right car refinancing loan for your situation.

Final Verdict

If you can’t afford to pay for a new car purchase in cash, your best option is to get a car loan. Learn how car financing works, and determine the type of loan that will be most beneficial for your specific circumstances. Bear in mind that a loan that requires a low monthly payment is always the best option.

You have to carefully study all the aspects of a loan. For instance, a low monthly payment may mean you have to pay the loan for a long time. You may be better off paying a little higher monthly installments that will allow you to pay off the loan sooner.

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