14 Car Loan Key Terms You Should Know

1. Down Payment

A down payment is cash you pay the vehicle seller or dealer toward the vehicle's total price. You can sometimes use your current vehicle's trade-in value or manufacturer incentives, such as cash rebates, as part of your down payment. The larger your down payment, the less money you need to borrow. In general, you should aim to make a down payment of at least 20% of a new car's purchase price and 10% of a used car's price. Since new cars typically depreciate by 20% in value after the first year of ownership, a smaller down payment could leave you upside down on the loan, which means you could owe more than the vehicle is worth.

2. Interest Rate

A loan's interest rate reflects how much you pay to borrow money. The interest rate is usually expressed as a percentage of the amount you borrow. With installment loans such as car loans, the interest is generally included in your monthly payment. Each month, part of your payment goes toward interest and the rest goes toward the loan's principal balance (the money you originally borrowed).

Learn more: How to Pay Less Interest on a Car Loan

3. Annual Percentage Rate (APR)

Interest is part of a loan's cost, but generally not the only cost. The APR of a loan reflects the total annual cost of the loan, including interest and fees, such as loan origination fees. APRs are expressed as percentages. When evaluating loans from different lenders, look at APRs to get a more accurate cost comparison than comparing only interest rates.

4. Term

The term, typically expressed in months, is how long you have to pay back the loan. As car prices rise, average auto loan terms are increasing. The average term of a new vehicle loan was 68.17 months in Q3 2024, according to Experian data, and some loans have terms of up to 96 months (eight years). Choosing a longer-term loan can lower your car payment, but longer-term loans generally have higher interest rates than shorter-term loans, ultimately costing you more money.

Learn more: Short-Term vs. Long-Term Car Loans

5. Principal

A loan's principal is the amount you're borrowing. Loan principal doesn't include interest. For instance, if it costs $40,000 to buy a vehicle, you might make an $8,000 down payment and finance the remaining $32,000. The $32,000 is the principal, which you'll pay back over time with interest.

6. Total Cost

The total cost is the full amount you will have paid to purchase a vehicle by the end of your loan term. It includes your down payment, the value of any trade-in, principal, interest and fees. Using the example above, a $32,000 loan with a 60-month term and a 6.61% interest rate will ultimately cost the borrower $5,666.01 in interest, bringing the total cost of the loan to $37,666.01. Adding the $8,000 down payment brings the total cost of the vehicle to $45,666.01.

7. Manufacturer's Suggested Retail Price (MSRP)

Sometimes called the sticker price or list price, the MSRP is the price that the auto manufacturer recommends dealers charge for a vehicle. Knowing the MSRP can give you a starting point for negotiating price when buying a car.

Learn more: What Is MSRP?

8. Prepayment Penalties

If you pay off your auto loan before the loan term ends, the lender loses out on some interest you would have paid. To compensate for this loss, lenders sometimes charge prepayment penalties for early loan payoff. Information about prepayment penalties must be included in the loan contract, but is sometimes hard to find; ask the lender or dealer if a loan includes a prepayment penalty.

9. Truth-in-Lending Disclosure

The Truth-in-Lending Disclosure is a document that gives borrowers key information about a loan. The federal Truth-in-Lending Act (TILA) requires lenders to provide this document before borrowers sign a loan contract (it may be included in the loan contract). The disclosure document must include:

• Loan APR: The loan's cost, including interest and fees
• Finance charge: The total dollar amount of interest and fees you'll pay over the term of the loan
• Amount financed: The dollar amount you're borrowing
• Total of payments: The total dollar amount required to pay off the loan, including principal, interest and fees

TILA documents must also state:

• The amount of your monthly payment
• The total number of payments you'll make during the loan term
• Any prepayment penalty
• Any late payment fees

10. Amortization

Amortization refers to how payments are applied to both principal and interest over the term of the loan. At the beginning of the term, most of each payment typically goes toward interest. Over time, more of each monthly payment goes toward principal. Throughout this process, your monthly payment amount will stay the same.

11. Cosigner

A cosigner is someone who agrees to take responsibility for repaying your auto loan if you don't make your payments. If you have poor credit, a low income or a limited credit history, lenders may require a cosigner to reduce their risk. Lenders will consider the cosigner's credit score, credit history and income as well as your own. The cosigner doesn't co-own the vehicle. Lenders typically want cosigners with a credit score of 670 or higher.

12. Extended Warranty

An extended warranty covers certain vehicle repairs after the manufacturer's warranty ends. Dealerships may offer you an extended warranty when you buy a car, with an option to roll the cost of the warranty into your loan amount. Extended warranties typically have many limitations and exclusions and can be expensive. Financing an extended warranty means paying interest on it, which adds to the cost of your car loan. Carefully review the details of any extended warranty; buying a vehicle with a lengthy manufacturer's warranty may make more sense.

13. Gap Insurance

Lenders or dealers may offer you gap insurance when you finance a vehicle. If your car is destroyed or stolen, your insurance company's payout for the totaled vehicle isn't always enough to repay your auto loan. Gap (guaranteed asset protection) insurance pays the difference between your car's actual cash value and the balance remaining on your auto loan. You may want gap insurance if you made a down payment of less than 20%, rolled an upside-down auto loan into a new loan or have a loan term of over 60 months. However, you can also buy gap insurance from auto insurance providers, usually at lower rates.

Learn more: Is Gap Insurance Worth It?

14. Credit Insurance

When you finance a car through the dealership, you may be offered credit insurance, which may cover your auto loan payments or repay your loan in full if you lose your job, die or become disabled. The cost of credit insurance is typically rolled into your loan amount, increasing the loan principal and the amount of interest you'll pay over your loan term. Consider whether other resources, such as disability insurance, unemployment insurance or life insurance, make credit insurance unnecessary.

How to Choose an Auto Loan

After reviewing the terms above, follow these steps to choose an auto loan.

• Check your credit report and credit score. Check your credit score several months before going car shopping so you have time to work on improving it if necessary. While you don't need a specific credit score to get an auto loan, higher scores could translate to lower interest rates.
• Decide what you can afford. Weigh your down payment, the vehicle's MSRP, taxes and fees to estimate how much you need to borrow. Consider how car payments, maintenance, insurance and fuel costs will affect how much you can afford.
• Shop for loans. Auto loans are available from banks, credit unions and online lenders. You can use online loan marketplaces to compare loans from multiple lenders. To minimize negative impacts on your credit, complete all your auto loan applications within a few weeks so credit scoring models treat them as one hard inquiry.
• Compare offers and get preapproved. Use Experian's car payment calculator to compare loan offers and select the best loan. If the lender preapproves you, it will give you a document indicating the estimated loan amount and interest rate you're approved for.
• Visit the dealership and select your car. Loan preapproval provides negotiating power to see if the dealer can offer better financing terms.
• Finalize your loan. Whether financing through your preapproved lender or the dealership, complete your loan documents and take possession of the car.

Learn more: The Best Way to Finance a Car

The Bottom Line

Actions to improve your credit score, like paying bills on time and reducing credit card balances, could help you qualify for lower auto loan interest rates. Also consider trying Experian Boost^®ø, a free feature that adds eligible on-time payments for your cellphone, utilities, rent and insurance to your credit report. Experian Boost could help increase your credit scores, potentially saving you money on your auto loan.