How Do Auto Loans Work? Auto Loans Explained

Apr 22, 2024 - 3 minute read

People signing paperwork at a desk in a car dealership.

Your Guide To All Things Auto Loans

Owning a vehicle has many benefits, but that luxury comes at a glaring price, with the average new car price rising to approximately $40,000. Luckily, you can still enjoy transportation freedom without breaking the bank when you score the right auto loan. If you're wondering, "How do auto loans work?" or if auto loans seem intimidating, don't fret. You can own the finances with the proper research and team to guide you. Read on to have auto loans explained so you can finance your dream ride at Aschenbach Automotive Group.

First Things First

The initial question, "How do auto loans work?" is based on these four main components:

  1. Price: the net cost of your vehicle

  2. Down payment: the amount you pay for your car upfront

  3. Principal: the amount you borrow in your loan

  4. Annual Percentage Rate (APR): the cost of your loan, including the interest rate and additional fees

With this preliminary introduction, let's learn each component's role in the auto loan process.

Set the Price

The first step to answering, "How do auto loans work?" is setting your price, and it's number one for a reason. Every component of your loan reflects the value of the vehicle's price tag. If you can afford to pay the total cost of your car upfront, that's ideal. If not, try to get as close as you can within reason. Conventional wisdom advises a down payment of at least 20% for a new car and 10% for a used car, as a substantial down payment saves you interest over time and could influence the favorability of your loan approval. Analyze your financial situation and consult financial experts to determine what down payment you can afford.

Determine Your Payments

The next step to answering the question, "How do auto loans work?" is what remains of the payment: the principal. The principal is calculated by subtracting your down payment from the vehicle's total price. The principal is the money you have to borrow for the loan and will be paid off through a fixed monthly payment. In addition to the principal, your APR will be added to the loan and calculated from the value of your principal balance each year. Thus, your APR will decrease as you progress through your monthly payments. However, you'll want to complete your loan quickly to reduce the interest you owe each year the loan remains outstanding. So, how long should your loan last?

Determine the Loan Duration

Once your vehicle price and the down and monthly payments are determined, the question of how auto loans work requires determining how long the auto loan should endure. According to Edmunds, the recommended duration of an auto loan is approximately 60 months. The reasoning behind this duration is that the shorter the loan, the less you pay in interest and the quicker you acquire equity, resulting in flexibility to sell or trade your vehicle. Aim to pay off your loan in 5 years or less as you set your budget, as while that might raise your monthly payments, you'll save more in the long run.

Finance Your Car With Ease

Now that you can answer the question, "How do auto loans work?" it's time to make it your own. Take into consideration the vehicle's price with your down payment, principal, and interest, and calculate your expected monthly payment. Go beyond just understanding car loans. Contact the financial specialists at Aschenbach Automotive Group to make your loan your own and determine financing fit for your budget.

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