How To Get A Car Loan

Read Time: 7 minutes

It’s challenging to come up with enough scratch to afford the full price tag on a new or used vehicle. Per Kelley Blue Book’s most recent data, the average transaction price of a new car is $47,401.

Meanwhile, Edmunds.com reports that the average price of a used car stands at $27,297. If you’re like many drivers, chances are you’re going to need some financing help in the form of a car loan.

Take the time to better understand how car loans work, the advantages and disadvantages of getting a vehicle loan, eligibility requirements, who offers car loans, steps involved in the process, what to consider carefully before signing on the dotted line, and alternatives to ponder.

How car loans work

Dennis Shirshikov, a finance and economics professor at the City University of New York, explains that getting a car loan involves borrowing a principal amount to purchase a vehicle, which is then paid back with interest over a set term – often between two to seven years (60 months is the most common term chosen).

Interest rates can vary widely, often depending on your creditworthiness and whether the car is new or used, with rates today ranging from as low as 3% to over 10% for those with less favorable credit scores.

“Currently, interest rates for new cars are often lower than expected thanks to current manufacturer incentives offered. Used cars, on the other hand, typically carry higher interest rates due to the increased risk associated with their resale value,” says Shirshikov.

“While most car loans come with a fixed interest rate, others may include varying interest rates or options like balloon payments, adding complexity to the loan’s structure.”

Note that most car loans allow you to make accelerated payments that can pay off the loan more quickly, which can provide significant interest savings.

Finance companies and lenders, including banks, credit unions, specialized auto finance firms, auto dealerships, and vehicle manufacturers themselves, offer these loans, incorporating various terms and conditions that can affect the total cost of borrowing.

It’s smart to shop for auto loans among various lenders, including any bank you already have an account with, and compare offers, rates, and terms carefully to find the best overall financing deal. 

The pros and cons of pursuing a car loan

Choosing a car loan can make good financial sense, particularly when you lack the cash to pay for it fully. It enables you to purchase a vehicle by spreading the cost over time. This can be especially beneficial when interest rates are lower and more favorable.

“This approach not only facilitates immediate vehicle ownership but can also contribute to improving your credit score and building credit, assuming your loan payments are made consistently and on time,” continues Shirshikov.

“However, the downside includes the accrual of interest – potentially increasing the overall cost of the vehicle. There’s also the risk of you becoming upside down on the loan, which means your loan balance surpasses the vehicle’s value.”

This can happen, for instance, if your auto is totaled in an accident and you owe more on the car than the car is worth.

“There’s also depreciation to consider. Your car is immediately worth less as soon as you drive it off the lot. Think of getting a car loan as trading off upfront convenience for additional financial responsibility over time,” says personal finance expert Shawn Plummer.

Here’s another caveat: Should you default on your car loan payments, the lender reserves the right to reclaim the vehicle. This action not only carries the potential of adversely affecting your credit score and financial stability but also leaves you without transportation.

Additionally, keep in mind that your car loan may impose limitations on any modifications you want to make to your car, such as installing aftermarket parts or accessories. Breaching these limitations may lead to warranty nullification or penalties imposed by the lender.

What’s needed to qualify for a car loan

Ryan Vann, vice president of consumer lending for PenAir Credit Union, notes that car loan qualifications will vary based on loan amounts and other credit criteria.

“In general, your credit report should indicate that you already have three well-established credit accounts that have been paid punctually. Your debt-to-income ratio should generally be below 45%, and you need to be prepared to provide a sufficient down payment, which may be required by the lender and help cover the taxes and fees related to the purchase,” he says. “I encourage buyers to look for a loan that will charge monthly payments that equate to no more than 15% of their monthly income to ensure affordability.”

Lenders commonly prefer a credit score of 660 or higher, a loan-to-value ratio that doesn’t exceed 80% (meaning you should have a 20% down payment saved), and a debt-to-income ratio ideally below 36%, per Shirshikov.

“Qualifying usually requires demonstrating a stable and sufficient income, too, as well as proof of auto insurance,” adds Plummer.

Steps involved with getting a car loan

To successfully obtain auto loan financing, count on completing these recommended steps:

  • Scrutinize your finances. Set a purchasing and car ownership budget based on your earnings, savings, outstanding debts, and what you can afford. 
  • Review your credit. Check your three free credit reports and resolve any errors or inaccuracies you spot. Also, check your credit score, and work to improve your score if it’s in the low range. You can up your score by paying your bills on time and in full (especially credit card balances), not opening any other new loans or lines of credit (before applying for a car loan), and not closing any older existing credit accounts.
  • Shop around among various lenders. Compare the interest rate, term, fees, and fine print carefully among all loan offers gathered to help make a more informed decision and determine the best deal.
  • Get preapproved for financing before car shopping. This entails submitting a loan application to a lender who will assess your creditworthiness and ascertain the loan amount and terms you’re eligible for. 
  • Go vehicle shopping at dealerships or among private parties. Compare your loan offers to any in-house financing offers available. Negotiate the car’s purchase price and tell the dealer/seller that you are prepared to buy once your loan is approved.
  • Finalize your loan. Provide anything that the lender requests, including special documentation, bank statements, and proof of employment and earnings. Look over the loan paperwork carefully and ask questions about anything you don’t understand. Then, await an underwriting decision. Finalizing the loan can take as little as one business day to a week or more, depending on the lender, with dealerships and online lenders typically approving loans more quickly than brick-and-mortar lenders.
  • Close on the loan and take possession of the car. Sign all necessary documents, make any needed down payment, and take ownership of the vehicle. 

Questions to ask before committing to a car loan

It’s a good idea to inquire about anything you don’t understand before signing on the dotted line.

“Ask about the full cost of the loan, including any applicable fees, as well as the length of the loan, if there are any prepayment penalties, and whether the interest rate is fixed or variable,” recommends Shirshikov.

In addition, ask what your total monthly payment amount will be, if any special incentives, discounts, or promotions are available that you may qualify for, if there are any additional conditions or terms to be aware of, and what happens if you make a late payment or can’t repay your loan. 

Car loan alternatives to consider

Taking out an auto loan isn’t the only way to finance a vehicle purchase. Instead, weigh the pros and cons of other borrowing options, including:

  • Tapping into your home’s equity. If you own a home, you may qualify for a home equity loan or home equity line of credit (HELOC), although you risk losing your home (not your car) if you cannot repay this debt, and the interest rates or total interest paid could be higher than you’d get for a car loan.
  • Pursuing a personal loan. You may be eligible for an unsecured personal loan that doesn’t require any collateral (meaning you don’t risk losing your car or home); however, this option will almost certainly come with a higher interest rate than a car loan would charge.
  • Using a credit card. A quick and convenient way to pay for a car is to use that plastic rectangle in your wallet – assuming you have a high enough credit/borrowing limit. But the average credit card interest rate today exceeds 20%. However, if you get approved for a card with a 0% introductory APR, you can use it to help buy a car and pay no interest on the charge if you repay your balance before the introductory period ends.

Erik J. Martin

Erik J. Martin is a Chicago area-based freelance writer and public relations expert whose articles have been featured in AARP The Magazine, Reader’s Digest, The Costco Connection, Bankrate, Forbes Advisor, The Chicago Tribune, and other publications. He often writes on topics related to real estate, personal finance, technology, health care, insurance, and entertainment. He also publishes several blogs, including Martinspiration.com and Cineversegroup.com, and hosts the Cineversary podcast (Cineversary.com).

Compare Rates and Save on Your Auto Loan

See Today's Rates