How do auto loans work?
Getting a car can feel a lot like going to a circus — for the main act, a car appears in your driveway and money disappears from your wallet.
With an auto loan, you agree to repay a lender over a set term, typically three to six years, in exchange for them paying a dealership (or a private seller) so that you can get a car. You generally pay more than what you borrowed, which equates to profit for the lender. How much more you pay largely depends on your credit score.
How will your credit score affect your car loan?
With a higher credit score, less of your paycheck will do a vanishing act. Since the lowest APRs (annual percentage rates) are offered to the borrowers with the highest credit scores, improving your credit score before applying for an auto loan can really be worth the effort.
The difference between the highest and lowest used-car APR in Q2 2022 was nearly 17 percentage points, according to Experian. On a 5-year loan for $25,000, for example, you could save nearly $12,700 over the life of the loan if you applied with a higher credit score.
Car loans for bad credit
If you have no credit history or you’ve made some credit mistakes along the way, it’s still possible to get car loans for bad credit. If you’d like to improve your chances of being approved or possibly secure a lower rate, consider adding a cosigner, making a large down payment or both. No matter your score, it’s important to shop around for your auto loan and compare multiple offers.
Types of auto loans
There are several types of auto loans, but here is a quick rundown:
- New auto loan: You’ve got plenty of options. Most lenders offer new car loans, including banks, credit unions, online lenders and the automakers themselves.
- Used car loan: You’ll find used auto loans at almost all the same places. However, some lenders place limits on the age and mileage of the cars they’re willing to finance. If you want a car that’s over ten years old or has over 120,000 miles, you typically have to get a personal loan instead.
- Private party car loan: Buying a used car from a person (rather than a business) requires a private party auto loan. This type of car loan can be harder to find, but banks and credit unions still offer them.
- Auto refinance loan: If you need a lower car payment, can qualify for a lower APR or want cash-out, an auto refinance could provide what you’re looking for.
- Lease buyout: At the end of a car lease, you have the option to turn in the car or buy it. A lease buyout loan lets you purchase the car and continue to make payments rather than paying a large amount to buy it outright.