How Do Car Loans Work?
August 12, 2025 • 5 mins
Article Contents
Financing terms you need to know
Get familiar with these terms before taking out a car loan:
- Down payment – an upfront payment that you make toward the purchase of a car. If you can, it’s best to make a down payment equal to 20% of the vehicle’s purchase price. When you make a down payment, you can take out a smaller car loan, which lowers your monthly payments.
- Principal – the amount of money you’re borrowing to buy the car, not including interest and fees.
- Interest rate – a fee your lender charges you for borrowing money. The interest rate is usually shown as a percentage of the loan amount. The lower the interest rate, the less you’ll pay for the loan. Different lenders offer different interest rates, so it pays to shop around.
- APR (annual percentage rate) – your loan’s interest rate plus other charges such as fees. Generally, borrowers who have higher credit scores get a lower APR. The APR gives you a full picture of the cost to repay your auto loan. So when comparing loan offers, pay attention to the APR.
- Loan term – the amount of time you’ll have to pay off your loan. Some common loan lengths are 24, 36, 48, 60 or 72 months. With a longer loan term, your monthly payments will be lower, but the interest adds up, so you’ll likely end up paying more for the car.
- Monthly payment – the amount you pay to your lender every month. Your monthly payment includes the principal, interest and any fees.
Explain the factors that determine your loan terms.
Did you know?
The average car payment is $734 for a new car and $525 for a used car, according to Experian.
What goes into determining your monthly car payment?
- A 48-month loan at 3.87% APR would make your monthly payment $630, and will cost $41,520 over the life of the loan.
- A 60-month loan at 5.04% APR will have a monthly payment of $528, and will cost $42,987 over the life of the loan.
- An 84-month loan at 9.07% APR has a $451 monthly car payment, and will cost $49,178 total.
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