How Car Loans Work
An auto loan is a secured installment loan used to purchase a vehicle, with the car itself serving as collateral. When you finance a car, the lender pays the dealer and you repay the lender in equal monthly installments over the loan term, which typically ranges from 36 to 84 months. Each payment includes principal (reducing the loan balance) and interest (the cost of borrowing). Understanding how car loans work helps you negotiate better terms, avoid common pitfalls, and minimize the total cost of vehicle ownership.
The average new car price in the United States has risen to approximately $48,000 as of 2025, and the average used car price is about $27,000. With these higher prices, the average monthly car payment for new vehicles has reached approximately $734, and for used vehicles about $525. The average auto loan term has stretched to nearly 68 months. While longer terms reduce monthly payments, they significantly increase total interest and the risk of being upside down (owing more than the car is worth).
Financial experts recommend the 20/4/10 rule for car buying: put at least 20% down, finance for no more than 4 years (48 months), and keep total vehicle expenses (payment, insurance, gas, maintenance) under 10% of gross monthly income.
Auto Loan Rates by Credit Score
| Credit Score | New Car APR | Used Car APR | Typical Approval |
|---|---|---|---|
| 780+ (Super Prime) | 4.5-5.5% | 5.5-7.0% | Best rates, longest terms |
| 720-779 (Prime) | 5.5-7.0% | 7.0-9.0% | Good rates available |
| 680-719 (Near Prime) | 7.0-10.0% | 9.0-13.0% | Moderate rates |
| 620-679 (Subprime) | 10.0-15.0% | 13.0-18.0% | Higher rates, shorter terms |
| Below 620 (Deep Subprime) | 15.0-25.0% | 18.0-25.0% | Very high rates; consider alternatives |
- 1Loan amount: $35,000 - $5,000 = $30,000
- 2Monthly rate: 6% / 12 = 0.5%
- 3Monthly payment = $30,000 x [0.005(1.005)^60] / [(1.005)^60 - 1]
- 4Monthly payment = $579.98
- 5Total paid: $579.98 x 60 = $34,799
- 6Total interest: $34,799 - $30,000 = $4,799
- 7Vehicle total cost: $5,000 down + $34,799 payments = $39,799
Tips for Getting the Best Auto Loan
Smart Car Financing
Canadian Auto Loan Market
Canadian auto loan rates are generally comparable to US rates. Canadian lenders include major banks (RBC, TD, BMO, Scotiabank), credit unions, and dealer financing. Auto loan terms in Canada typically range from 36 to 96 months, though financial advisors recommend staying under 60 months. Canadian auto loans are subject to the Interest Act, requiring clear disclosure of the annual rate. In Quebec, the Consumer Protection Act provides additional auto financing protections. Canadian buyers should also factor in provincial sales taxes (GST/HST), which add 5-15% to the purchase price depending on the province.
Cars depreciate rapidly; a new car loses 20% of its value in the first year and about 60% over 5 years. If you finance more than 80% of the purchase price on a long term, you may owe more than the car is worth for years. This is called being 'underwater' or 'upside down' and makes it difficult to sell or trade the vehicle. Always put enough down to stay ahead of depreciation.