How Do Auto Loans Work? Learn How to Find The Best Rates & Quotes

Do you know if an auto loan is the right financial move for you? You've come to the right place. Learn how they work and how to find the best rates in town.
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Finding the house of your dreams is simple, but getting pre-approved for a mortgage isn’t always a walk in the park.

Thankfully, when it comes to car shopping, understanding financing options and lending criteria is a more straightforward process.

Vehicles could always be paid for in cash, but for most families balancing various financial obligations, such as handling household bills or paying off debt, this isn’t the most feasible option.

This is exactly why borrowing money to purchase a car is one of the most popular ways to secure an automobile, whether it’s boasting a brand new paint job or having a few thousand miles under its belt.

If an auto loan is the right financial move for you, then you’ve come to the right place. From illustrating how auto loans work to finding the best rates in town, this resource breaks down the auto loan process step-by-step.

How Do Auto Loans Work?

To explain the nuts and bolts of auto loans, let’s take a look at a real-world example.

Betty wants to purchase a new SUV so she has more storage space and better mileage for her business trips. Even though she’s almost settled all of her college debt, Betty doesn’t want to pay for the vehicle in cash this time around.

This means Betty needs a more accessible way to purchase the vehicle, so she begins exploring financing options. She decides to contact a local bank to discuss lending criteria and the pre-approval process.

Betty learns that with an auto loan, the bank agrees to loan a certain amount of money to the borrower as long as both the loan and any accumulated interest are paid off within a specific time frame. The secured auto loan would be paid off through monthly installments.

Once Betty agrees to these terms, her new SUV is then considered the secured loan’s form of collateral.

In other words, if Betty doesn’t pay monthly installments on time, not only would the vehicle be repossessed, but the lender (the bank) would also need to sell the SUV to compensate for the unsettled debt.

Lenders certainly have some skin in the game.

Before diving into which factors impact auto loan approval, let’s review some basic terms most auto lenders want you to already know.

See current auto loan rates with LendingTree>>

Auto Loans – Basic Terms

Loan Cost

According to most lenders, loan cost refers to the principal plus the interest. In simple terms, the principal is the negotiated amount you’ll agree to pay back for the vehicle in writing.

As would be expected, there’s an associated cost for this borrowed principal amount – the percentage interest rate.

Borrowers should also be aware of APR, or the annual percentage rate handled on a yearly basis. Unlike your base interest rate, the APR includes other associated costs, such as loan origination fees.

Down Payment

The down payment is the balance the purchaser is willing to pay out-of-pocket before needing to take out an auto loan.

There is an important inverse relationship here – the bigger the down payment, the less money you’ll need to borrow from a lender (and the less mounting debt you’ll have to keep tabs on).

This means the more money you save up on a down payment, the less you’ll have to worry about expensive monthly payments.

You may even encounter attractive perks for a sizeable down payment, such as a lower interest rate.


If you can’t secure an ideal auto loan due to a sub-par credit score, a co-signer would be held legally responsible for paying off the loan if or when you default.

A co-signer is generally someone you’re close to and can trust, such as a close relative or spouse.

Since the co-signer must have already achieved a favorable credit ranking, he or she would play a huge role in helping you land a better auto loan.

Although securing a co-signer helps boost one’s credit score in the long run, the co-signer’s creditworthiness is ultimately put at risk by being named a party in your car purchase.

Your relationship with the co-signer could also become strained due to any financial hardship along the way. These are important factors to keep in mind if considering a co-signing agreement.


Equity essentially revolves around the following question: “How much of your car do you really own?”

If you decide to pay for your car in cash, you would have a huge equity stake in your new purchase.

But, if you finance your vehicle from day one, you’ll have to slowly build up your equity by making monthly payments.


Sometimes your dealer will let you choose between a lower interest rate (such as 0% financing) or an attractive one-time cash rebate generally ranging from $1,000 to upwards of $3,000.

The rebate option is often an attractive incentive for purchasers, especially since the rebate amount can be deducted from the vehicle’s principal cost. Or, you can always ask for the rebate in the form of a check.

Which Factors Impact Auto Loan Approval?

Although more factors could be added to this list, the following are some of the most relevant you should be aware of:

  • Credit Score: With bad credit, you’re less likely to be approved for a loan in this competitive industry. Higher interest rates would also come with the territory, but every lender has specific criteria.
  • Debt Load: Lenders know that if you already have mounds of debt, you’ll probably face some difficulty handling loan payments. It’s best to tackle current debt before taking on any more.
  • Loan Term: Similar to an insurance policy’s term, this is the amount of time borrowers are given to finalize the loan. Longer terms mean lower rates, but higher interest will catch up with you.
  • Vehicle Type: A new car’s shiny price tag usually equals high-interest rates. Pre-owned cars often entail lower principal, but depending on the dealer, new cars can lead to manageable interest rates.

Get quotes from multiple banks at LendingTree>>

Other Associated Costs

When you bring home a new pet, there are other associated costs to consider other than the up-front payment. There is food to purchase, vet bills to plan for, and grooming items to consider.

In a similar vein, once you’ve secured a new car through an auto loan, there are various associated costs to keep in mind, such as auto insurance or sales tax:

  1. Car Title and Registration: Let’s make things legal. Fees can cost upwards of $200, but the age and weight of the car generally determine the total fee amount.
  2. Sales Tax: Like most items, there’s a standard sales tax to consider. Make sure to calculate the sales tax into your final expenditure report.
  3. Auto Insurance: You don’t want to drive your brand new car uninsured. Car loans don’t include auto insurance as a standard provision, and your lender will probably require proof of insurance.
  4. Dealership Fees: When purchasing a car from the dealership, you can anticipate documentation fees. If you’re shipping a car from another lot, that’s also a fee. But, these fees are negotiable.
  5. Maintenance Fees: To ensure your car is running smoothly for years to come, you’re going to need to get your oil changed, tires rotated, and engine checked, among other common repairs.
  6. Common Add-Ons: Similar to insurance riders, common extras range from extended warranties to paint protection. Some are worth your while, but others are irrelevant and overpriced.

Where Should I Shop for Auto Loans?

With the auto-finance industry skyrocketing in recent years, it can be hard to determine whether a brick-and-mortar agent or online lender is the best option for your needs.

For first-time auto loan shoppers, getting the best deal shouldn’t feel like trying to find a needle in a haystack.

That’s why we’ve demystified the best places to shop for auto loans so you don’t have to:

Virtual Lenders

In our tech-savvy society today, you can explore auto loan options with the click of a few buttons.

Since visiting brick-and-mortar locations isn’t always the most convenient alternative, virtual lenders have become popular alternatives for auto loans.

Better yet, you can avoid overhead costs from more traditional lenders when you work with a lender online.

Since you aren’t meeting face-to-face, do your research to ensure the lender is legitimate. You also may not be informed exactly how your personal information is shared, and expect emails and phone calls from quite a few lenders.

See rates from several lenders with LendingTree>>


What do most people typically associate with the term “loan?” You guessed it – banks. In other words, the holy grail of financial institutions.

Using state-of-the-art technologies, banks regularly issue competitive quotes to qualified auto loan borrowers.

However, banks usually cater to applicants with favorable credit rankings. Applicants with marginal credit may encounter difficulty securing an auto loan through a bank, and inflated loan fees only further complicate matters.

Not all is lost, though. Most car shoppers have established a checking or savings account with a bank, so a good rule of thumb is to visit a local branch or review your bank’s website for auto loan criteria.

You may even qualify for a lower interest rate if you set up automatic payments for your loan.

Credit Unions

Compared to banks, credit unions generally handle lower overhead. For you, the customer, this means lower interest rates, straightforward applications, and more flexible loan options for those facing bad credit.

But, if you wanted to book a face-to-face appointment with a credit union representative, local branches are often small in number.

If you’ve already established a working relationship with a local bank, then you may want to skip the credit union and stick with what you know.

Car Dealerships or Manufacturers

Sometimes it’s nice to go ahead and square away an auto loan while you’re already at the dealership.

Just be aware that dealerships often arrange loan packages through lending networks, so you may not be getting the best bang for your buck. To really flesh out the nitty-gritty of your loan, consider working with a bank or credit union instead.

Manufacturers, such as Honda, often offer specially discounted loans when qualified individuals buy a vehicle from one of their dealerships.

Loans arranged through a manufacturer can usually be applied online. However, these loans are typically geared toward those with favorable credit.

How to Find the Best Rates

When searching for the best auto loan at the best rate, you can implement several tried-and-true strategies to stay on the right track:

Step 1: Stick to a Strict Budget

This means simply creating a realistic budget for you and your family and don’t stray from it. Lenders shouldn’t work the numbers behind the scenes – make the numbers work for you.

Some people like to go the old-fashioned route with pen and paper, but others prefer the convenience and reliability of an Excel sheet.

Not only should you be calculating the total loan amount, estimated monthly payments, and interest rates, but also your current debt-to-income ratio.

Your debt-to-income ratio is exactly what it sounds like – the amount of monthly income you must allocate toward various debt payments, such as college debt or a mortgage.

Therefore, if you see an imbalance in this ratio, you may want to hold off on an auto loan.

Step 2: Analyze the Total Loan Amount

While sifting through miles and miles of auto loan quotes, it’s important to look at the big picture. In this case, the total loan amount you’ll be responsible for.

Yes, you’ll more than likely handle the loan through monthly payments, but the total loan amount determines the length of time you’ll pay installments.

The longer you stretch out your monthly payments, the lower rate you’ll experience. But, there is a small price to pay for lower rates – inflated interest in the long term.

With longer monthly debt payments, your fiscal resources will steadily deplete, making it harder to save for retirement or supplement an emergency cash fund. Choose your battles wisely.

Step 3: Understand the Pre-Approval Process

When you take that dream car for a test drive, don’t let your emotions get the best of you.

Getting pre-approved by a lender before heading to the dealership makes the car buying experience less of a hassle.

You already know the loan criteria you’re working with, so don’t let the dealer try to stretch your wallet even further.

If you’re offered a better deal from the dealer, then go with it. Banks and credit unions are always great resources if you want to pin down the pre-approval process from the start.

Step 4: Explore Pre-Owned Vehicles

Don’t let the fancy bells and whistles of a brand new car distract you from finding the best auto loan on the market.

Your vehicle’s inherent market value drops or depreciates once you drive it off the lot, so it doesn’t hurt to see your dealership’s pre-owned offerings. Most of these cars still look brand new.

Even though the pre-owned lot generally boasts lower loan principal due to lower price tags, lenders know used cars are purchased more often by individuals with inferior credit.

These purchasers pose a liability risk for lenders, so in this case, higher interest rates are common.

No matter if you purchase a new or pre-owned vehicle, always have the car inspected off-site by an automotive specialist for any mechanical issues or major repair work.

Step 5: Compare Quotes

Before making any final decisions on an auto loan, research what different lenders have to offer.

This process entails contacting lenders, comparing quotes, and using personal calculator tools to avoid any deals you may regret. Understand where your credit stands, and don’t always assume the lender has your best in mind.

With a little time and research, you can land an auto loan that fits your current financial situation.

Compare quotes with LendingTree>>

Step 6: Read the Fine Print

This means checking over the math and making sure everything adds up. Remember, since you’re signing paperwork you’ll be legally bound to, there are real and lasting consequences to not handling payments responsibly.

For starters, take a look at provisions related to variable interest rates, repossession conditions, or mandatory binding arbitration.

On another note, steer clear of any auto loans marketed as “contingent” or “conditional.”

Here, you may experience financing terms a few months down the road that is a far cry from what you’d originally had in mind. This situation could lead to unforeseen financial hardship.

Remember, a verbal agreement is not an agreement set in stone. Before you show off that brand new car, a finalized written agreement needs to be in hand. Also, realize there could be prepayment or refinancing penalties hidden in the contract.

Final Thoughts on Auto Loans

Whenever you need a vehicle but can’t afford to pay in cash at the dealership, an auto loan may be a move in the right direction.

Both financial responsibility and the trustworthiness of the borrower are highly valued by lenders when it comes to securing auto loans, so understand what’s at stake when signing the paperwork.

While reading over the fine print, make sure what you’re signing only entails negotiated terms you agreed to. This is a foolproof way to avoid any unforeseen costs when you least expect it.

Once you compare quotes from different lenders, understand the major factors affecting auto loan approval, and recognize other associated costs, you can confidently approach the dealership lot.

If you’re still not sure if an auto loan is right for you, determining your debt-to-income ratio and current credit standing is a good place to start.

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