What is a car loan
An auto loan is an installment loan to buy a vehicle, secured by the vehicle itself. The lender is listed as the lienholder on the title until the loan is paid off. You can borrow directly from a bank or credit union, or through the dealer, which arranges financing with partner lenders.
Auto loans are simple-interest loans: interest accrues daily on the outstanding balance. Terms of 60–72 months are common, and 84 months is widely available.
Key features
- The car is collateral. To sell it before payoff, the loan must be paid off and the lien released.
- Insurance. State law requires liability coverage in almost every state; lenders also require collision and comprehensive (“full coverage”) for the life of the loan.
- Credit score matters a lot. Rates for subprime borrowers can be several times higher than for borrowers with excellent credit.
- New vs. used. Used-car loans carry higher rates, and many lenders limit the age and mileage of the car.
- Negative equity. Cars depreciate fast; with a small down payment and a long term you can owe more than the car is worth for years.
Ways to finance a car
Direct loan from a bank or credit union
Getting pre-approved gives you a benchmark rate before you visit the dealer. Credit unions often offer some of the lowest rates.
Dealer financing
The dealer sends your application to several lenders. The lender approves a “buy rate,” and the dealer may add a markup (often up to about 2–2.5 percentage points) as compensation. That markup is negotiable.
Manufacturer (captive) offers
Automakers’ finance arms advertise 0% or low APR on new cars. Often you must choose between the low APR and a cash rebate — calculate both: a rebate plus a credit-union loan can be cheaper than 0% APR.
Leasing
You pay for the car’s depreciation over the lease term plus a finance charge (the “money factor”), with mileage limits and wear-and-tear charges. Lower payments, but you own nothing at the end unless you buy the car.
Add-ons and dealer pitfalls
- Add-ons — extended service contracts, GAP, credit life, paint protection — are often rolled into the loan and accrue interest. They are optional; you can decline them or buy GAP from your insurer, which is usually cheaper.
- Payment-focused selling. Stretching the term lowers the monthly payment but increases total interest. Negotiate the price first, then the financing.
- “Spot delivery.” If you drive off before financing is final, the dealer may later say the deal fell through and offer worse terms. Don’t sign a new contract under pressure.
- Precomputed interest. Federal law bans the “Rule of 78s” on precomputed consumer loans longer than 61 months; prefer simple-interest loans.
Before visiting a dealer, model several scenarios in SMARTPRO — different terms, with and without add-ons, 0% APR vs. a rebate — and compare total cost.
Car loan interest deduction (2025–2028)
For tax years 2025 through 2028, you can deduct up to $10,000 a year of interest on a loan taken out after December 31, 2024, to buy a new vehicle for personal use whose final assembly was in the United States. The deduction is available whether or not you itemize and phases out above $100,000 of modified AGI ($200,000 for joint filers). Leases and used cars don’t qualify.
How terms differ between lenders
| Term | How it can differ |
|---|---|
| Rate | By credit tier, term length, new vs. used; dealer markup over the buy rate. |
| Term | Maximum term (72, 84 or more months) and higher rates for longer terms. |
| Vehicle limits | Age, mileage, private-party purchases, maximum loan-to-value. |
| Fees | Origination or documentation fees; dealer “doc fees” vary by state. |
| Add-ons | Which products are offered and how hard they are pushed. |
| Early payoff | Most simple-interest auto loans have no prepayment penalty, but some contracts and states differ. |
Checklist
- Get pre-approved by your bank or credit union before shopping.
- Negotiate the out-the-door price before discussing monthly payments.
- Compare APR and total cost for the same term — and compare 0% APR against the cash rebate.
- Ask for the contract without add-ons and review every line item.
- After payoff, make sure the lender releases the lien and you receive the title.
This material is for general information only, describes US rules in effect on the publication date, and is not financial, legal or tax advice. Federal and state rules, programs and lender terms change — always check your loan documents, your lender’s current terms and official sources such as the CFPB and IRS.