In 2016, more vehicles were purchased than in any other year in history—to the tune of 17.5 million cars, trucks, and SUVs. Even though car buying is at an all-time high, most American consumers don’t have enough money set aside to pay for a vehicle outright. Instead, vehicle loans are used to spread the purchase price out over a period of months or years, making it more feasible to fit a new or used car into the budget.
If you’re one of the millions of people looking to buy a vehicle without unloading a significant amount of cash up front, here are the most common auto loan terms you need to know.
What is an auto loan APR?
A vehicle loan is fairly straightforward in that a lender, be it a bank, finance company, or a credit union, offers to pay a lump sum for the car you want to purchase. You are then responsible for repaying the balance, plus interest, over a set period. Most car buyers misunderstand the dollars and cents of a vehicle loan, however—especially when it comes to the interest rate.
Defined by the Consumer Financial Protection Bureau, an interest rate is the cost you pay each year to borrow a certain amount of money, expressed as a percentage of the loan outstanding. When it comes to buying a car, the interest rate is almost always discussed as an annual percentage rate, often referred to as the APR.
What is the difference between a monthly loan payment and a down payment?
There are two main auto loan terms that relate to your immediate cost of borrowing for your new car: the monthly loan payment and the down payment. The monthly loan payment is the fixed amount of principal and interest you pay each month to your lender. No matter what happens in your financial life, you’re on the hook for this payment until the loan is repaid in full, so be sure to evaluate your ability to repay an auto loan before getting caught up in the excitement of a new car. If you aren’t sure what to expect, you can easily calculate your estimated monthly loan payment using our online tool found on a dealership’s website.
In addition to the monthly loan payment, you may need or want to bring a down payment to the dealership to purchase your vehicle. A down payment is a single, lump sum you pay out of pocket to the dealership or lender. This amount is not included in your loan, but instead shows your lender you have some skin in the game. Depending on a number of factors, a down payment may or may not be required. In most cases, especially when there is an APR being charged, it is to your benefit to have a down payment—and usually, the bigger down payment you can afford, the better.
What are auto loan terms and conditions?
Having a good understanding of the APR, monthly payment, and down payment is necessary in the car buying process, but so is recognizing the differences between loan repayment terms and special conditions.
Your loan term is the length of time you have to repay the amount financed, typically stated in months. A 72-month auto loan will have a lower monthly payment than a 36-month loan because the repayment is spread out over more time. However, a lower monthly payment may mean you pay more in interest—remember that APR?—making it important to evaluate these details closely. It’s also helpful to remember that the longer your loan term, the more interest you’ll accrue, so you want to pay off your loan sooner rather than later.
Before you sign on the dotted line, take the time to read your loan agreement and uncover any special conditions that might void your financing or make your auto loan more expensive. For instance, some vehicle loans come with a prepayment penalty, which means you could be hit with a fee for paying off the full loan balance too quickly.
Financing the purchase of a vehicle is common practice, but buyers who get the most bang for their buck take the time to understand how auto loans work. Get familiar with these terms before hitting the dealership lots, and take the time to estimate your payment to ensure it fits well within your budget.