Auto Loan

How it works

The borrower picks a vehicle, agrees on a price, and either pays cash or finances the purchase. With an auto loan, the lender pays the dealer in full; the borrower repays the lender plus interest in fixed monthly installments. The car serves as collateral — if the borrower defaults, the lender can repossess the vehicle and sell it to recover the balance.

A typical structure:

• Term — three to seven years (36 to 84 months). Longer terms reduce the monthly payment but mean more total interest and a higher chance of being underwater.
• APR — varies sharply by credit score. A prime borrower (760+) might get 5–7% on a new car; a subprime borrower (below 620) might pay 15–25%.
• Down payment — typically 10–20% of vehicle price. Lower down payments increase loan size and the risk of negative equity.

Negative equity

Cars depreciate quickly. A new car typically loses 20–30% of its value in the first year. A 7-year loan with a small down payment can leave the borrower owing more than the car is worth — "underwater" or "upside down" — for several years. If the car is totaled or the borrower needs to sell, the loan balance exceeds the proceeds and the borrower writes a check to close out the difference.

The single biggest factor making this worse is loan terms creeping longer. Average new-car loan terms in the US extended from about 60 months in 2010 to over 70 months by 2025, allowing dealers to advertise lower monthly payments while the borrower ends up underwater for most of the loan's life.

Dealer financing vs. credit unions

Dealer-arranged financing is convenient but often expensive. The dealer marks up the rate from what the actual lender quoted, pocketing the spread. A pre-approved loan from the borrower's own bank or credit union — secured before walking onto the lot — typically yields a better rate and removes a major dealer pressure point during negotiation.

Leasing vs. buying

Leasing pays only for the depreciation and interest during the lease term, with no ownership at the end. Monthly payments are lower than an equivalent auto loan, but the borrower never builds equity. Leasing makes sense for buyers who want a new car every two to three years and don't drive heavily; buying makes sense for buyers who plan to keep the car well past the loan payoff. The cost-of-ownership math favors buying-and-holding for ownership periods longer than about five to seven years.

Refinancing

If credit improves significantly during the loan, refinancing the auto loan can lower the rate. Less common than mortgage refinancing because the dollar amounts and rate differences are usually smaller, but worth running the numbers when rates fall meaningfully.