Buying a car is an exciting milestone, but it’s also a major financial decision that requires careful planning. An auto loan can help make that purchase possible, but before you sign on the dotted line, it’s important to consider a number of factors. Taking out an auto loan isn’t just about getting the money you need to buy a car—it’s also about understanding how the loan will affect your finances in the short and long term.
In this article, we’ll walk you through everything you need to consider before applying for an auto loan. From your credit score to interest rates, and from monthly payments to lender options, we’ll cover the key points that will help you make an informed decision and secure the best deal for your financial situation.
1. What is an Auto Loan?
An auto loan is a type of personal loan that helps you finance the purchase of a vehicle. When you take out an auto loan, you borrow money from a lender, which you then use to buy the car. In return, you agree to pay back the loan in monthly installments, typically over a period of 24 to 72 months, depending on the loan terms.
There are two main types of auto loans: secured and unsecured. A secured auto loan means the vehicle you’re buying acts as collateral for the loan. If you fail to make payments, the lender has the right to repossess the car. Unsecured auto loans, though less common, don’t require collateral but usually come with higher interest rates since they are riskier for the lender.
2. Your Credit Score and Loan Eligibility
One of the first things a lender will look at when considering your application for an auto loan is your credit score. Your credit score is a numerical representation of your creditworthiness and indicates how likely you are to repay the loan. Generally, a higher score will help you qualify for better loan terms, including lower interest rates.
For most auto lenders, a credit score of 700 or higher is considered excellent, while scores between 650 and 699 are considered good. If your score is below 650, you may still qualify for a loan, but you might face higher interest rates and less favourable terms.
If your credit score is lower than desired, consider taking steps to improve it before applying for an auto loan. Pay off existing debts, avoid opening new credit accounts, and check your credit report for any inaccuracies that could negatively impact your score.
3. Loan Amount vs. Car Value
Before you apply for an auto loan, it’s essential to decide how much you need to borrow. This amount should align with the car’s value and your financial situation. Lenders will often allow you to borrow up to a certain percentage of the car’s value, typically around 80% to 100%.
When determining how much to borrow, don’t forget to consider the down payment. A larger down payment reduces the loan amount and can help lower your monthly payments. In some cases, putting down a higher percentage can also help you secure a lower interest rate.
4. Interest Rates and Loan Terms
Interest rates are one of the most important factors in determining how much your auto loan will cost you. A lower interest rate means you’ll pay less over the life of the loan, while a higher rate can make your car more expensive in the long run.
Auto loan interest rates can vary depending on factors like your credit score, the loan amount, and the length of the loan. Typically, shorter loan terms (e.g., 36 months) come with lower interest rates, while longer terms (e.g., 72 months) may offer lower monthly payments but tend to have higher overall interest costs.
Be sure to shop around for the best interest rate, as even a small difference in rates can add up over the life of the loan.
5. Monthly Payments and Budgeting
One of the most important aspects to consider is how much you can afford to pay each month. While it may be tempting to take out a loan with a longer term and lower monthly payments, this could result in paying more interest over time. Shorter loan terms typically come with higher monthly payments but cost less in interest.
Before applying for an auto loan, create a budget that accounts for the monthly loan payment, as well as other car-related costs, such as insurance, gas, maintenance, and registration fees. Make sure that you can comfortably afford the monthly payments without putting undue strain on your finances.
6. Loan Fees and Additional Costs
In addition to the interest rate, auto loans may come with various fees. Some lenders charge an origination fee for processing the loan, while others may impose penalties for early repayment or late payments. Be sure to ask the lender about any fees associated with the loan before committing.
You’ll also need to factor in additional costs associated with purchasing a car, such as taxes, registration, insurance, and any extended warranties or add-ons. These costs can add up quickly, so make sure you have a clear understanding of the total cost of the car before finalising the loan.
7. Secured vs. Unsecured Auto Loans
As mentioned earlier, auto loans can be secured or unsecured. Secured auto loans are the most common, with the car acting as collateral for the loan. If you default on the loan, the lender can repossess the car to recover the debt. Because of the collateral, secured loans generally come with lower interest rates.
Unsecured auto loans, on the other hand, don’t require collateral. While this means you won’t risk losing your car, it also means the lender takes on more risk. As a result, unsecured auto loans typically come with higher interest rates and stricter eligibility requirements.
8. Loan Term Length: Short vs. Long Term
The length of your loan term will have a significant impact on both your monthly payments and the total interest you pay. A short-term loan (24 to 36 months) typically comes with a higher monthly payment but costs less in interest over time. On the other hand, a long-term loan (60 to 72 months) spreads the payments out and offers lower monthly payments, but you’ll end up paying more in interest over the life of the loan.
When choosing the loan term, consider your budget and long-term financial goals. If you can afford higher monthly payments, a short-term loan may be a better choice. However, if you need to keep your monthly payments low, a long-term loan may be more suitable.

9. New vs. Used Car Loans
When financing a car, you’ll need to decide whether to buy new or used. New cars typically come with lower interest rates, as they have a higher resale value and are less risky for lenders. Used cars, while often more affordable, may come with higher interest rates because they are more likely to lose value quickly and may be in less-than-perfect condition.
If you’re looking for a more affordable car and are willing to pay higher interest rates, a used car loan might be a good option. Just make sure the car is in good condition and that you’re comfortable with the loan terms.
10. Lender Options: Banks, Credit Unions, and Dealerships
There are several different places to get an auto loan, and each offers different pros and cons. Banks and credit unions generally offer competitive interest rates, especially for borrowers with good credit. Credit unions, in particular, may offer more flexible terms and lower rates for their members.
Car dealerships often offer financing as well, but the interest rates may be higher. However, dealerships may also have special promotions, such as 0% APR for well-qualified buyers, which can make their offers more attractive.
11. What to Do if You Can’t Repay the Loan
If you find yourself struggling to make your car loan payments, it’s important to act quickly. The longer you wait, the more difficult it can become to catch up. Contact your lender to discuss your options, such as extending the loan term or adjusting the payment schedule.
If you’re unable to repay the loan and fall behind on payments, the lender may repossess your car. This will negatively affect your credit score, making it harder to borrow money in the future.
Conclusion
Taking out an auto loan is a significant financial commitment that requires careful consideration. From interest rates to loan terms, and from lender options to additional costs, there’s a lot to factor in before applying for an auto loan. By taking the time to research and understand your options, you can make an informed decision and secure a loan that fits your budget and financial goals.
FAQs
- What credit score do I need to get an auto loan?
A credit score of 700 or higher is generally considered good for getting an auto loan with favourable terms. - Can I get an auto loan with bad credit?
Yes, but you may face higher interest rates and more limited options. - How much should I put down on an auto loan?
A down payment of 20% is recommended to reduce the loan amount and lower monthly payments. - What is the best loan term for an auto loan?
A 36-month loan term is often the best option if you want to pay off the loan quickly and save on interest. - Can I refinance my auto loan?
Yes, refinancing can help you secure a lower interest rate or adjust the loan term. - What happens if I miss a car loan payment?
Missing a payment can result in late fees, a drop in your credit score, and potentially repossession of the vehicle. - Should I buy a new or used car with an auto loan?
New cars usually offer better financing options, but used cars are more affordable and may still have great financing deals available.