Auto Loans

An auto loan is any loan you get for the purpose of buying a car. Typically, auto loans are available from dealers, banks, credit unions, and online lenders, and repayment terms can last up to seven years or more. Most require your car as collateral for the loan. However, some loans, like personal loans, are unsecured. This means you can borrow money to buy a car without putting your car up as collateral. Personal loan rates may be higher than secured auto loans, but if you miss payments, you don’t risk repossession.

To get an auto loan:

1. Start by checking your credit report for errors or inaccuracies. If you find any, dispute those immediately.
2. Know your budget. Even if a lender will approve you for a higher loan amount, stick to your budget and a payment (and vehicle) you know you can afford.
3. Prequalify with multiple lenders to get a sense of rates available to you based on your credit. Many auto lenders let you prequalify without impacting your credit. (When you apply, lenders will conduct a hard credit check, which could temporarily lower your credit score.) Some dealerships will not let you prequalify, which means your credit may be impacted by checking your rate.
4. Once you have an idea of rates, use an auto loan calculator to figure out how much car you can afford — plug in your maximum monthly payment and your prequalified rate to arrive at a maximum vehicle price. If you plan on financing sales tax and license and registration fees, deduct that from the loan amount you can afford to get the car’s price.
5. Shop for cars. Online dealers and retailers may auto-populate a monthly payment while you shop — but it’s often based on good-credit rates. If yours is not, change the credit score range if that’s an option, or plug the car’s price into an auto loan calculator to get your likely monthly payment.
6. Choose your car. Once you’ve found the car you want, you’ll need to formally apply for a loan. The lender will run a hard credit check when you apply, which could temporarily lower your credit score.
7. Provide required documentation and any additional information during the loan approval process.
8. Review the terms of the loan agreement before you sign — make sure there are no items required for the loan that you did not agree to, such as gap insurance.

Auto loan rates are impacted primarily by your credit history, current debt, and income. They’re also affected by whether the loan is secured. Traditional auto loans that require the vehicle as collateral typically have lower interest rates than unsecured loans, like most personal loans, that don’t require collateral. However, if you miss payments on a secured loan, your car may be repossessed. If you miss payments on an unsecured loan, the lender cannot claim your car as collateral.

Many people don’t have the funds to pay cash to buy a car, so a car loan is essential. Plus, it lets you spread out payments evenly over the life of the loan, which can last several years. Since most car loans are secured by the car itself, you can enjoy lower interest rates relative to unsecured loans. Plus, you can find out whether you’re approved for a car loan in minutes, in most cases.

However, car loans do have some drawbacks. Perhaps the largest is that cars generally depreciate in value once you buy them, especially if you buy new. You could be upside down on your auto loan while you still owe on it (meaning the car is worth less than what you owe). This can make selling the car difficult or impossible. And if you can’t make payments, your car could be repossessed by the lender. One exception is if you use an unsecured personal loan to buy a car, in which case, the lender can’t take your car if you miss payments.

To compare auto loans, consider more than just the monthly payment. Look at the annual percentage rate (APR) and the length of the loan. The APR accounts for the interest rate and fees to give a better sense of the loan’s cost compared to the interest rate alone. The length of the loan indicates how much you’ll pay in interest overall. For example, you’d pay $5,415 in interest on a five-year, $25,000 car loan with an 8% interest rate, and your monthly payment would be $507. However, if you lower the payment to $438 by extending the term to six years, you’d pay $6,560 — over $1,000 more — in interest.

An auto loan can affect your credit score in a few different ways:

1. When you apply for an auto loan, your credit score may temporarily drop.
2. If you make timely payments and pay off the loan, you may improve your credit score.
3. You could improve your credit mix (the different types of debt you have) by taking out an auto loan, which improves your credit score.
4. Late and missed payments will likely hurt your credit score.
5. Defaulting on an auto loan could hurt your credit score significantly.

If you need a car, but don’t want to or can’t get a traditional auto loan, you have a few options:

1. Use a personal loan: A personal loan is typically an unsecured loan that does not use the car as collateral. This can be a good option for older cars and classic cars for which traditional financing is unavailable.
2. Lease a car: Leasing a car is similar to a long-term rental. You have annual mileage limits and don’t get to keep the car once the lease is up. However, your monthly payment is often much lower than what it would be if you purchased the car.
3. Use a ride-hailing app: If you don’t drive frequently, maybe you don’t need a car at all. Consider the cost of using apps like Uber and Lyft for your driving and delivery needs compared to the cost of owning a car.
4. Use a subscription service: Some companies, like FINN and SIXT, offer a subscription car service. In exchange for a monthly fee, you can drive one of their vehicles over the long term. There’s no down payment and you aren’t committed to a specific car for years. But mileage may be limited and you may be charged extra for insurance and taxes. This can be a reasonable way to procure a vehicle if you don’t know what you want. Note that a credit check is required.

Yes, like most loans, you can refinance an auto loan. This could make sense if you’ve improved your credit, if interest rates have fallen, or if you’d like to pay your car off faster. Some lenders let you prequalify without hurting your credit, so you can see if it makes sense to refinance before you apply. When you apply, the lender will conduct a hard credit pull, which could ding your score for up to a year. If you have equity in your car, you may even be able to refinance and pull cash out — but unless you qualify for a lower interest rate or extend your loan’s term, this could increase your monthly payment.