How Do Auto Loans Work?


If you are like many other car buyers, you will probably be planning to apply for a loan. Auto loans are almost the only way to be able to afford to purchase a car these days, as vehicle costs have soared in the past few years. For example, the average price for a new vehicle was up 6.3 percent in the past year. The price of used cars climbed 43 percent from February 2020 to September 2022.

All of that translates into more people relying on a loan to finance their new or used cars. As recently as 2022, approximately 31 percent of adults in the U.S. said they planned to get an auto loan to pay for their car. An additional 14 percent said they plan on getting an auto loan in the first half of 2023.

The question then becomes how to go about obtaining a loan for your vehicle purchase. Among the factors that come up; are the number of years that you have to pay the loan off, the down payment amount, and the interest rate – which plays a significant role in how much your down payment will be.

Here, we will explain the process involved in securing a car loan. After reading this article, we expect you will have a solid understanding of how car loans work.

What is a Car Loan?

When you don’t have enough available cash to pay for a new car outright, you can choose to pursue a loan to help you purchase it. This can apply to a new or used automobile.

Obtaining an auto loan begins with you borrowing money from a lender to purchase a car. You agree to pay back these funds over a period of time, in addition to fees and interest on the dollar amount borrowed.

Important Terms to Know for a Car Loan

Before explaining the process involving car loans, it is helpful to be aware of certain common terms that you will come across while securing and processing your vehicle loan. Knowing these terms will benefit you as you explore various options for financing your car.

Annual Percentage Rate (APR) — An APR is the amount you will be paying to borrow money for your vehicle purchase. It will include lender fees, and it is expressed as a percentage. The higher your APR, the more money you’ll owe in return for the loan.

Down Payment — This payment is what you pay upfront toward the cost of your automobile. You have the option to pay cash, the value of a vehicle trade-in, or both. The downpayment helps decrease the total dollar amount you need to finance – and that could translate into lower monthly payments.

Loan Term — Also referred to as loan duration, this is the length of time you have to pay off your car loan. Loan terms are in 12-month increments, with examples being 48, 72, and 84 months. Keep in mind that the longer your loan term, the more you’re likely to pay in interest.

Monthly Payment — Your monthly payment is the dollar amount you pay every month. Your monthly payment is comprised of the principal, interest, and other fees, if applicable.

Principal Amount — This is the amount of money you originally agreed to pay back. It excludes interest.

Interest Rate — This is similar to an APR, however, without the loan fees included. Because fees can vary from lender to lender, it is best to use the APR when comparing loan offers for a more accurate comparison.

Amortization — This is the process of paying off your car loan that sends a portion of your payment toward principal and a portion to interest. In the early stage of your loan, a higher percentage of your payment goes to interest. And later, more of your payment will be applied to the loan principal. As a result, your principal will be reduced more quickly toward the end of the loan.

Total Cost — The total cost refers to the total loan amount, or overall principal and interest, that you will pay over the life of your car loan.

Process of Obtaining a Loan

Buying a new or used car is one of the most consequential purchases you’ll make in your life. There are many aspects to the loan process that you’ll need to be aware of.

The car loan process begins with you receiving a lump sum of money from a lender to purchase a car. Then, you have the vehicle and you are responsible for making monthly payments on the loan – with interest over time. Until you pay off the entire loan amount, the lender holds the title to the car and can repossess it if you fail to make the payments on time or fall short with your payments.

In order to receive a vehicle loan, you will need to apply and be approved by a lender. You have the choice to apply at a credit union, a bank, with an online lender, or at the car dealership.

Your monthly payments will be based on the dollar amount of the loan, as well as the loan term, and the amount of interest you will need to pay over the course of the loan. The loan contract is broken down into the principal and the interest on the car loan, along with optional add-ins.

The length of a car loan will typically be 60 months or 72 months (five years or six years), and those longer durations will make your monthly payment lower. It is important to know that the longer your term is, the more you’ll pay over the life of the loan when you factor in the interest.

There are some lenders who will pre-qualify you for a loan in as little as a few minutes and estimate an interest rate based on your credit history and answers to basic questions. Once you settle on a car, you will select the best loan offer, submit a detailed application, and then wait for the lender to verify your information and approve the loan.

A pre-approved loan means the application and verification steps are done ahead of time.

3 Factors that Influence Your Monthly Payment

A Lower Loan Amount

As an example, perhaps you are considering a $25,000 vehicle loan, but you make a $2,000 down payment or negotiate the price of the car down by $2,000. Your loan amount becomes $23,000, and you pocket the savings of $44.27 per month – assuming a 3.00 percent APR and a four-year term.

 A Lower APR

With that same $25,000 vehicle loan, assume a four-year term. One financial institution offers a 3.00 percent APR and another gives you a 2.00 APR. Taking the lower APR will save you $10.98 a month.

A Longer Loan Term

Extending a $25,000 loan from four years to five years – assuming a 3.00 percent APR – lowers your monthly payment by $104.14. However, you will still have to pay $391.85 more in interest charges over the life of the loan.

Look to California Community Credit Union to Set Up Your Next Auto Loan

At California Community Credit Union, we are known for our affordable auto loan rates. We are also experts at generating low-cost personal loans for our clients.

We offer these loans for people in Sacramento, Roseville, Modesto, and Elk Grove, all located in California. We at California Community Credit Union (CACCU) specialize in auto loans, as well as personal loans.

When you secure your auto loan with CACCU, you are assured of receiving the best – and lowest – loan rates that are available. We offer low rates and flexible terms on every vehicle loan, new and used.

You’ll also appreciate a car loan with CACCU, as our used car loans apply to 2004 through 2023 model years. Unlike most auto loans through other lenders and credit unions, if you have a vehicle that is more than 10 years old, it will not result in a higher interest rate with CACCU.

If you’re ready to get started on your auto loan, we invite you to contact CACCU and we will get you set up with the best loan terms and conditions that enable you to drive away with major savings!

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