What is an Auto Loan? 3 MVP Terms to Note
As of the end of 2022, the average loan amount financed for a new vehicle increased to $41,445. But what does that huge number really mean? Understanding "what is an auto loan" starts with a basic definition and three key terms to make sure you're getting a good deal.
Or do you already have an auto loan? Find out if you should or should not get a car loan refinance.
What is an Auto Loan? 🤔
An auto loan is when you borrow money to buy a vehicle.
You'll work with auto loan lenders from a credit union or bank to borrow the funds, and then you'll pay them back monthly.
Auto Loans are also known as car loans or vehicle loans. You can get an auto loan for new or used trucks, cars, SUVs, motorcycles, and more, as long as you qualify.
Some commonly used terms you'll want to know include:
Definition: Principal is the amount you borrow.
Tell me more: The more you borrow, the more borrowing will cost. After all, the finance charge is determined by multiplying the interest rate times the principal. So the more you can reduce your principal, the more affordable borrowing will be.
Example: Li's new car costs $23,000. If Li puts a down payment of $3,000, then her principal amount (or amount of the loan) is $20,000. She'll pay interest (see below) on that $20,000.
Bottom line: Make the largest down payment you can afford so that you reduce the amount you're borrowing - principal - as well as reduce your overall auto loan interest costs.
Definition: The length of time the loan lasts.🕓
Tell me more: The term of your loan affects what it costs you to borrow. A shorter term means higher monthly payments (because you have less time to pay it back) but a lower total cost (because you aren't accruing interest for as long). The reverse is also true. A longer term means lower monthly payments but a higher total cost.
Example: For a $15,000 loan at a 7.5% APR, the cost monthly and total cost will vary based on term. The monthly payment for a three-year term would be about $467, a four-year term would be $363, and a five-year term would only be $301. But the interest and finance charges go the opposite direction. It would cost you about $1,798 in interest for the three-year term, $2,409 for the four-year term, and $3,034 for the five-year term.
Bottom line: You still might choose the longer term, and the higher cost, if the smaller monthly payment is what fits into your budget. But keep in mind that a car might start to cost you money for upkeep after it reaches a certain age or you’ve driven it long distances. You don’t want to choose so long a term for your car loan that you’ll still be paying it off while also having to pay for major repairs.
3. Annual Percentage Rate (APR)
Definition: APR is the percentage of the loan principal you pay to your credit union or bank every year to finance the loan for your vehicle.
Tell me more: This percentage is added to the principal amount borrowed, and is usually repaid monthly over the course of the term.
Example: If you took out a $15,000 four year car loan with a 7.5% auto loan interest rate, the minimum monthly payment would be about $363. If you only made minimum payments throughout the life of the loan, you would pay $2,408 in interest, meaning that you'll be on the hook for $17,408 total (principal + interest).
Bottom line: Get the lowest auto loan interest rate you can from your lender. Just be wary of deals that seem too good to be true (0% interest offers often have a catch in the auto loan terms).
Here's your chance to play with the numbers for your specific financial situation. Follow the coach down below to figure out how much you can put towards a vehicle loan. 👇
Not-So-Hidden Costs of an Auto Loan
Keep in mind that you should include the cost of auto insurance when deciding "what car should I buy?" and "what monthly payment can I afford?" Your insurance premium will vary depending on factors such as where you live, your age, the types of auto insurance you choose, and the car you buy. Generally, the newer and more expensive the car is, the more expensive it will be to insure.
Other car-related expenses include fuel, oil changes, maintenance items such as filters and bulbs, and more. We like to suggest making sure you have room for all of these before you go out and buy a car, auto loan or not!
And if you need help in your car search, be sure to check out our fool-proof guide: Happy Car Buying: Your Ultimate Guide to Getting the Best Deal.
This article is intended to be a general resource only and is not intended to be nor does it constitute legal advice. Any recommendations are based on opinion only. Rates, terms, and conditions are subject to change and may vary based on creditworthiness, qualifications, and collateral conditions. All loans subject to approval.