Car Loan Basics

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If you've never financed a car before, the whole process can be a bit overwhelming. You have to look at the mechanics of the loan you're getting, from the interest rate and annual percentage rate (APR) to the length of the loan and how much you're paying over the long haul. Then there's the down payment and your monthly payment. It's like making soup; all the ingredients should come together properly to make it appealing.
 
With all that in mind, Lithia Motors thought you could use a basic Auto Loan 101 article to explain all the terms and tell you how it all works together. The more you know about auto financing, the better prepared you'll be to negotiate a great loan. Season to taste.

Auto Loan 101

It is often said that other than buying a house, purchasing a new or used car is one of the biggest expenditures you will ever make. That's just one of the reasons why spending extra time on understanding car loans is so important. As of this writing in 2023, new car prices continue to climb and the average cost for vehicles in America can be staggering. Take a look at these average prices for various types of automobiles today.
Average Car Prices

 
On average, Americans are spending $48,763 on a new vehicle. That means if you are in the market to buy a car, chances are you'll need an auto loan. The best thing you can do to be prepared for that major purchase is to do your homework concerning your next car loan. So, let's start at the beginning.
Compact Car = $26,622
Compact Crossover SUV = $35,280
Electric Vehicles = $58,385
Mid-size Sedan = $31,533
Full-size Sedan = $47,342
Full-size Pickup Truck = $47,342
Minivan = $46,631
Hybrid Crossover = $36,057
Luxury Sedan = $74,048

Car Loan Terms

Unless you have the cash in hand to buy a car, you'll need a loan to pay for it. Whether you get your loan from a bank, a credit union, or from the car dealership where you buy the car, you'll be borrowing money and paying it back over time and those payments will include interest, fees, and taxes in your state. Here are car loan terms you'll need to know and understand.

Annual Percentage Rate (APR)

is the yearly interest percentage you'll pay on the loan including interest and fees. In other words, it is the cost to borrow the money as a yearly percentage and is a more complete measure of the loan's cost than the interest rate alone.
is the upfront money you put down on a vehicle. It can be in the form of cash, the value of your trade-in car, or a combination of both. The more your down payment is up front, the less money you'll need to borrow and the lower your monthly payments will be.
is the duration of the loan and tells you how many months you'll be paying off the loan amount. The loan term can be anywhere from 24 to 72 months. Longer loan terms mean you'll pay less per month, but you'll also pay more in interest.
is how much you'll have to pay each month on the loan for its duration. It includes the principal, interest, fees, and any late penalties. You'll have to really look at your monthly budget to make sure you can afford that monthly payment before you sign the loan contract.
is the amount you will be borrowing for the car with all other costs such as interest, fees, and penalties stripped away.
is the complete loan amount including all principal and interest charges. It tells you how much you are spending on the car over the entire course of the loan.

How Car Loans Work

If you have a car to trade in, your first step is to find the value of that vehicle. You can do that right here on the Lithia Motors site by using our trade-in value calculator. Once you subtract the trade-in amount and any cash you have as your down payment on a new car, you are ready to get pre-qualified for a car loan. More on that in a minute. You will pay the loan off through monthly payments over time. Your monthly payment amount will be determined by the loan term and how much interest you will pay.
 
Longer term loans will make your monthly payment lower, but the longer the loan term, the more you'll pay in interest. Credit Karma suggests that on a $20,000 loan at 3.75% interest, a 3-year loan (36 months) would give you a monthly payment of about $588 and you'd pay a total of $1,177 in interest. Under the same conditions, a 5-year loan would bring your monthly payments down to about $366 per month but you would pay $1,965 in interest. And those calculations do not include state sales tax. In that scenario, the longer loan would mean you'd pay $788 more in interest over the entire loan.

Where to get a Loan

You can obtain an auto loan for a new, used, or certified pre-owned car. New car loans generally have lower rates and often include special incentives from the automaker compared with used car loans. When you are ready to shop for a loan, it is best to do your research on what car loans you qualify for. The better your credit score, the better deal you are likely to get. Check with several lenders including banks and credit unions to see what is currently being offered.
 
You can get financing through the car dealer you buy the car from, and often that is the most convenient option. You can shop for your new vehicle and get a loan right at the dealership. Car dealers have relationships with a number of lenders so that you are able to choose from several loan options. Plus, the dealership is used to working with the vehicle manufacturers for low rate incentives.
As mentioned earlier, you can go to several banks or other lending institutions to comparison shop and be prequalified for a car loan. You can do this right online to discover real rates and monthly payment amounts that you can live with. Checking to see if you are prequalified does not impact your credit score and you'll be able to go to the dealership knowing how much you can spend, what you can afford, and see if the dealer can beat the bank's rates.
Do Your Research
Before looking into getting an auto loan, look over your monthly household budget to get an idea of how much of a monthly payment you can afford and check your credit scores. If your credit could use some work, do an online search for lenders who work with low-credit borrowers.
 
Keep in mind that when you buy a car, the dealership will offer you a number of add-ons to the vehicle such as extended warranties, lifetime oil change contracts, and other goodies that can add to the total cost of your loan and increase your monthly payment. Know what you are buying and always go over the loan contract with a fine-tooth comb before signing.
What you'll need to Apply for a Car Loan
Armed with all the information in this article, you're ready to dip your toes into the car loan ocean. You'll need to research and find a car loan that makes sense for you and your budget. When submitting a loan application you'll need your:
  • Social Security number
  • Driver's License
  • Past and Current Address
  • Employment Info 
  • Income Statement 
The lender will do a soft pull on your credit when you prequalify that will not affect your credit score. However, once prequalified, if you move ahead with getting the loan, the lender will pull a hard inquiry which can cause a temporary dip in your credit scores.
Let Lithia Help
With over 75 years of experience in providing personal transportation solutions for our customers, Lithia Motors can help you get an auto loan that works for you so we can get you into the car of your dreams. We've got your back and want to keep you as a customer for life.