How Do Auto Loans Work? Car Payments & APR

What is an auto loan?

An auto loan is a type of installment loan used to finance the purchase of a vehicle.

When you use an auto loan, you borrow money to cover part of the vehicle's cost and repay the loan over a set period of time through scheduled payments. These payments generally include both principal and interest.

The vehicle typically serves as collateral for the loan, which means the lender can repossess it if the loan is not repaid as agreed.

How does an auto loan work?

When you finance a vehicle with an auto loan, a lender provides the money needed to cover the amount you are financing. You then repay that amount over a set period of time through scheduled monthly payments.

Each payment generally includes principal and interest. The principal reduces the amount you owe, while interest represents the cost of borrowing the money. As you make payments, the amount you owe gradually decreases until the loan is repaid.

Key terms

Understand the parts of an auto loan

Vehicle Price

The price of the vehicle before considering financing and other costs.

Down Payment

Money paid upfront toward the vehicle purchase. A larger down payment can reduce the amount financed and the amount of money on which interest may be charged.

Amount Financed

The amount borrowed through the auto loan. It can include the vehicle price and certain additional costs, minus amounts paid upfront or otherwise credited toward the purchase.

APR

Annual Percentage Rate. APR expresses an annual rate associated with the cost of borrowing and can help you compare financing offers.

Learn more about APR

Loan Term

The length of time scheduled to repay the loan, usually expressed in months.

Monthly Payment

The amount scheduled to be paid each month. It is affected by factors such as the amount financed, interest rate, and loan term.

Interest Rate (IR)

The percentage used to calculate the interest charged on the amount borrowed.

How is an auto loan payment calculated?

For a typical fixed-rate auto loan with equal monthly payments, the principal-and-interest payment can be estimated using an amortizing loan formula:

M = P × r(1 + r)ⁿ (1 + r)ⁿ − 1

M

Monthly Payment

The estimated monthly principal-and-interest payment.

P

Principal

The amount being financed.

r

Monthly Interest Rate

The annual interest rate converted to a monthly rate.

n

Number of Payments

The total number of scheduled monthly payments.

The formula shows why the amount financed, interest rate, and loan term can all affect your monthly car payment.

Try it yourself

See how interest rate and loan term affect an auto loan

Keep the vehicle price, down payment, and amount financed fixed. Change the interest rate and loan term to see how they affect the estimated monthly payment and financing cost.

Vehicle Price $30,000 Fixed for this example

Down Payment $5,000 Fixed for this example

Amount Financed $25,000 Simplified example

Interest Rate 7%

3% 15%

Loan Term 60 months

36 months 84 months

Estimated monthly payment $495.03

Estimated financing cost $4,701.80

Estimated total of payments $29,701.80

Using the loan formula Monthly payment

P = $25,000 · IR = 7% · n = 60

M ≈ $495.03

Want to use your own values? Open Full Calculator

This simplified educational example uses the annual interest rate to estimate the monthly principal-and-interest payment. Actual loan payments and borrowing costs can vary depending on the lender, loan terms, fees, and other financing costs.

What changed and why?

See how interest rate and term affect the loan

Change the interest rate or loan term in the example above to see how each one affects the loan. In this simplified estimate, a higher interest rate increases the estimated financing cost, while a longer loan term can lower the estimated monthly payment but increase the estimated financing cost.

Compare loan terms

Shorter term vs. longer term

A lower monthly payment does not necessarily mean a lower-cost loan.

Shorter term

Higher monthly payment

The loan is repaid over fewer months, so each monthly payment is generally higher.

However, the balance is generally repaid faster, which can reduce the total interest paid.

Longer term

Lower monthly payment

Repayment is spread across more months, so each monthly payment is generally lower.

However, borrowing for a longer period generally increases the total interest paid.

Key takeaway

What should you remember?

An auto loan allows you to spread the cost of a vehicle across scheduled payments. The amount financed, APR, and loan term all affect the cost of borrowing.

A longer loan term can reduce the monthly payment, but it can also increase the total interest paid. Looking at both the monthly payment and the total cost of the loan gives you a better picture of what the financing actually costs.

Continue learning

Explore more borrowing concepts

Continue learning how loans, repayment, and financing costs work.

Mortgages

Learn how mortgage loans work and what affects the cost of financing a home.

Amortization

Learn how loan payments are divided between principal and interest over time.