Not many people have enough cash on hand to walk into a dealership and purchase a car outright. For this reason, car loans exist to help those who need to finance a vehicle. Auto loans can come from many sources, like banks, credit unions, dealerships, or online lenders. When you take on a loan, someone else provides the cash to the dealership to buy the car, and you repay them with interest. Interest is the cost of borrowing money from a lender, and it differs for each customer.
Here's what you need to know about car loans.
Understanding the Components of a Car Loan
The price tag for the car you’re looking to buy is just the start of the total cost if you’re financing. Unless you qualify for a 0% APR loan deal, the bulk of the cost comes from the interest paid to the lender on top of the selling price of the car.
Here are some quick definitions of the parts of a car loan that you need to know:
Principal – The Amount You Borrow
When you're borrowing money from someone, the amount you borrow is called principal. It does not include the interest you're charged as the cost of borrowing that money.
When you talk to a lender and strike a bargain that differs from the MSRP, or manufacturer's suggested retail price, you will also have a negotiated selling price. The amount that you're borrowing from the lender could include additional costs above the vehicle's negotiated selling price. This price, plus the taxes, title, and license fees, and additional surcharges, combine to create the principal amount of the loan.
Interest Rates – What They Are and How They Are Determined
Interest rates are the cost of borrowing money from a lender to buy a car, expressed as a percentage, and are largely determined by your credit score. Interest charges are the charges that accrue over time on the principal of your loan based on your interest rate. Your loan balance and interest charges determine how much you pay for your loan.
Your interest rate determines how much interest you’re charged over time. Nearly every car loan uses a simple interest formula, meaning your interest charges accrue daily based on the balance of your loan.
Each time you make a car payment, part of that payment is applied to the interest first, and the rest to your principal. You can ask to see an amortization schedule that outlines how much of your car payment is applied to your principal and interest each month.
Over time, less of your monthly payment is used to pay interest, and more is put toward your principal loan balance. By the time you're near the end of your loan, the majority of your payments are applied to the principal until it’s repaid.
Loan Term – How Long You Have to Repay
Loan terms determine how long you have to repay a loan. They are expressed in months, with the most common loan term being around 5 years, or 60 months. Terms are typically 36 to 72 months. Some short-term loans, between 12 and 24 months, and longer, 84-month terms do exist, but they aren't as common. The shorter you make your loan term, the more expensive your monthly payments will be, but the more you will save on interest charges.
How Car Loan Payments Are Calculated
Car loan payments are calculated using a complex mathematical formula in which you need to know your loan principal, your annual interest rate, and the loan term you're borrowing for. Then you can start the math.
The Car Loan Payment Formula and How It Works
The car loan monthly payment calculation is: M = P * [ r(1+r)^n] / [ (1+r)^n -1] , where M=monthly payment, P=principal, r=interest rate, and n=number of months.
This formula can be a little daunting to do by hand, so it helps to find a car loan calculator online where you can punch in your figures and find out your monthly cost.
You can also find a number of resources online, such as our own payment calculator.
Factors That Affect Your Car Loan
There are many factors that will impact your auto loan, including where you live, which vehicle you're purchasing, and which lender you're working with.
On top of all of this, though, is your credit score. Your credit score is probably the biggest factor that affects your car loan. This is because interest rates are determined by your credit score.
The Impact of Credit Score on Interest Rates
Credit scores impact interest rates, so the better your credit score, the lower the interest rate you're likely to be approved for on a car loan. Your lender sets your APR, or annual percentage rate, based mostly on your credit score.
According to the latest Experian State of the Automotive Finance Report, for the third quarter of 2025, the average new car interest rates range between 4.88% for the best credit scores and 15.85% for the lowest scores. For used cars, the average runs between 7.43% and 21.6%.
Credit scores range from 300 to 850 on both the FICO credit score model and the VantageScore model, which is used by Experian. FICO has historically been the most widely used credit scoring model by auto lenders. The point that separates "good" credit from "bad" credit is around 670 on both scales.
How Vehicle Type Influences Your Loan Amount
New vehicles tend to cost more than used ones. However, whether you're purchasing a new or used vehicle will impact your interest rates and, in turn, your loan amount beyond the initial amount you're approved for. According to Experian, average loan amounts vary greatly when you're getting approved for a new versus a used car. The current average amount financed for a new vehicle is $42,332, while the average amount financed for a used car is currently $27,128.
Loan Terms Impact Overall Loan Amount, Too
The shorter your loan term, the more you will pay in average monthly payment amount, though you'll rack up fewer interest charges since you're not taking on a long loan. Often, borrowers will opt for the longest loan term they can, which diminishes their monthly payment amount but raises the overall amount of interest they pay, since interest accrues over time. The longer the loan, the more interest you pay, increasing your loan amount.
Down Payment Amount Will Impact Your Overall Loan
Lastly, know that the amount you put down on your next vehicle will change the overall principal of the loan. When you get all the numbers worked out, you're normally required to put a certain amount down. Once you make your down payment, it's subtracted from the loan amount, leaving you with the final total you'll have to pay. If you want to lower your monthly payments and pay less in interest charges overall, you should put down as much as you can on a car loan.
