An auto loan is a type of loan used to purchase a vehicle that a borrower can't afford to buy outright.
This loan allows the borrower to pay an up-front portion (usually around 20%) to the lender and the lender
provides the remaining portion of the cost to the seller.
In exchange for providing the rest of the cost,
the buyer will repay the lender over a period of time (anywhere from 24 to 84 months) while paying interest
on the amount of money owed to the lender.
A car is not an investment, and it will lose value over time. This loss in value is called depreciation and
is typically quite steep for newer vehicles.
On average, a new car loses about 20% of its value in the first year and 10%-15% each subsequent year.
It's important for potential buyers to understand that vehicles are not investments and will cost money to
maintain while losing value over time.
However, depreciation can be used in a buyer's advantage if they wait to buy a car until it is a few years
old, as the price will be significantly lower than the original MSRP. For example, a car that costs $40,000
new may be available for around $25,000 after only three years.
It's important to note that depreciation is not linear, and that most loss (or gain depending on if you're
buying) occurs in the first few years. The value lost after the seventh year is nowhere near the same as in
the first.
Furthermore, different cars depreciate at different rates, and some cars even appreciate in value
over time. For example, on average, after 5 years a Toyota will have retained around 63% of its value,
while a Jeep will have only retained about 46%.
Typically, a cars depreciation can be linked to its reliability, and the more reliable cars depreciate less.
This is why reliable brands like Toyota, Lexus (owned by Toyota), and Honda tend to have a better resale
value. If you're interested in comparing brands and models, this website may
be helpful.
For example, an average new car loan with a loan amount of $40,000 and an average interest rate of 7.2% over
60 months could result in nearly $8,000 in interest paid over the life of the loan. This is a significant
amount of money that could be used for other purposes, such as saving for retirement or paying off other
debts.
The calculator below is a great tool to see how much a car loan will cost you, not only per month, but also
over the course of the loan.
When deciding how on large of a loan you can afford, it can be helpful to remember that your debt-to-income
ratio should be no more than 36%. This means that your total monthly debt payments (including your mortgage,
car loan, and any other debts) should not exceed 36% of your gross monthly income.
Furthermore, it's important to remember and plan for other costs like insurance, gas, maintenance, and
repairs. Many people see the monthly payment of a car loan and assume that they can afford it. After all,
what's an extra $100 or $200 a month? However, this is a mindset often leads to financial stress or even car
repossession.
After evaluating your current debts, income, and estimated expenses you should find a vehicle that fits your
budget. Buying a new car is exciting, and even a little nerve-wracking, but you should never overextend
yourself financially. If you can't afford the car, you shouldn't buy it.
Interest rates for auto loans can vary dramatically based on a number of factors, including the borrower's income, down payment, length of loan, credit score, and whether the vehicle is new or used. Typically, higher credit scores will be offered lower interest rates and so will loans on new vehicles.
| Credit Score | Avg APR, New | Avg APR, Used |
|---|---|---|
| 781-850 | 4.77% | 7.67% |
| 661-780 | 6.40% | 9.95% |
| 601-660 | 9.59% | 14.46% |
| 501-600 | 13.08% | 19.38% |
| 300-500 | 15.75% | 21.81% |
As you can see, both credit score and the whether the vehicle is new or used have dramatic affects on APR. The rate a borrower can get is also affected by market lending rates, which can vary dramatically based on the Federal Reserve. Below you'll find a graph of the average auto loan rates for 5 year terms on new cars. Unfortunately, it's difficult to find public data for used cars, but you can infer the used-rates based on the table above.