Auto loan
Also called car loan
A loan for buying a vehicle, secured by the vehicle itself, which the lender can repossess if payments stop.
What it means
Auto loans are available from banks, credit unions and dealerships, which often arrange financing through partner lenders. Because the car is collateral, rates are usually lower than for unsecured loans. Terms commonly range from 36 to 72 months, and some go longer.
Longer terms lower the payment but increase total interest, and since cars lose value quickly, a long loan with little down can leave the borrower owing more than the car is worth. Getting preapproved before visiting a dealer gives a rate to compare against dealer offers.
Formula
M = P × r(1 + r)^n / ((1 + r)^n − 1)
- M = monthly payment (principal and interest)
- P = amount borrowed
- r = annual interest rate ÷ 12
- n = total number of monthly payments
Example
For example, $30,000 at an illustrative 7% for 60 months costs about $594.04 a month and $5,642 in total interest. Stretching to 72 months lowers the payment to about $511.47 but raises interest to about $6,826.
How it’s used
- Buying a new or used car
- Refinancing a high-rate car loan
- Comparing dealer financing with a bank or credit union offer
Strengths and weaknesses
Strengths
- Spreads a large cost over time
- Secured, so rates are usually lower than unsecured debt
- Fixed payments make budgeting easier
Weaknesses
- Car can be repossessed after missed payments
- Long terms raise total interest and the risk of owing more than the car is worth
- Dealer add-ons can be bundled into the loan
Good to know
- Negotiate the car’s price separately from the financing and the trade-in.
See it in the data: Used car prices relative to inflation →
Related terms
Educational information only, not financial, tax or legal advice. Rules, limits and rates change; check the IRS, your lender or plan, or a qualified professional before acting.