How Does Financing a Car Work?

What Does It Mean to Finance a Car?

When you finance a car, you typically make a down payment that's a percentage of the car's price. You then get an auto loan for the rest of the car's purchase price from a bank or other financial institution and use the loan proceeds to buy the car.

Example: If you're financing a new car priced at $40,000, you might make a 20% down payment ($8,000) and get an auto loan for the remaining $32,000.

Auto loans are a kind of installment credit. You'll repay the loan, plus interest, by making fixed monthly payments over a set period, such as 48 or 60 months. When the loan is paid off, you own the car free and clear.

It's important to know that the vehicle serves as collateral for an auto loan. If you fail to make your payments, the lender can repossess your car—that is, take it and sell it to recoup the outstanding loan balance.

Learn more: What Are the Different Types of Car Loans?

Leasing vs. Financing a Car

Think of leasing a car like renting an apartment and financing a car like buying a home. When you finance a car, you borrow money to purchase the car and repay the loan over time in fixed monthly payments. When the loan is paid off, you own the car and can keep it, sell it or trade it in to buy a new car.

When you lease a car, you make fixed monthly payments to use the car for the term of the lease, typically two to four years. When the lease term ends, you typically return the car to the dealer and lease a new one. You may also have the option to buy the car, or you can return your leased car and purchase a different one.

Leasing appeals to people who want to always drive a newer car without the hassle of repeatedly buying and selling vehicles. Although both leasing and financing generally require down payments, the down payment and the monthly payment for a leased car are usually lower than the cost to finance the same model. In addition, leased cars are typically under warranty during the lease.

On the downside, you won't build any equity in a leased vehicle. Your mileage is generally limited, and there can be costly termination fees if you break your lease early. Although the upfront costs and monthly payments are generally lower, in the long run, leasing a car usually costs more than buying one.

Learn more: Is It Better to Lease or Buy a Car?

How Do Car Loans Work?

There are several elements that make up an auto loan, including your down payment amount, interest rate and loan term. Here's a closer look.

Down Payment

The down payment is an amount of cash you put down to get an auto loan. Making a down payment of at least 20% for a new car typically qualifies you for better loan terms. In addition, new cars lose about 20% of their value in the first year of ownership, so a 20% down payment protects you from owing more than the car is worth (called being upside down on your loan). The bigger your down payment, the less money you'll have to borrow, and the less interest you'll pay over the loan term.

Tip: A minimum 10% down payment is usually recommended for used cars. Used cars don't depreciate as quickly as new ones, so you can make a smaller down payment without fear of owing more than the car is worth.

Annual Percentage Rate (APR)

Even if two loans have the same interest rate, lender fees can vary. The APR takes both interest and fees into account to reflect the total cost of borrowing money. Comparing APRs helps ensure you're comparing apples to apples when evaluating multiple loan offers. The APR you qualify for depends on a range of factors, including your credit score, down payment and loan term.

Monthly Payments

The monthly payments are the amount you pay the lender each month to repay the loan. Monthly payments are fixed amounts that include both principal and interest. To keep payments manageable, aim for a monthly car payment that's 10% or less of your take-home pay. Missing a car payment can hurt your credit score, and if you miss too many payments, the lender could repossess your vehicle.

Loan Term

Your loan term is how long it takes to repay the loan. You can find car loan terms from 36 to 72 months or more. Opting for a longer loan term can lower your monthly payments, but generally means you'll pay a higher interest rate and more total interest over the life of the loan. You can usually lower your interest rate and save on total interest by choosing a shorter loan term; just keep in mind this will mean higher monthly payments.

Example: Suppose you buy a $40,000 car, putting down $8,000 and financing $32,000 at an interest rate of 6.80% (the average rate for a new car loan in June 2025, according to Experian's State of the Automotive Finance Market report). Here's how different loan terms impact the cost of financing:

48-month loan term:

• Monthly payment = $763.31
• Total interest = $4,639.07

84-month loan term:

• Monthly payment = $479.84
• Total interest = $8,306.83

Tip: Use Experian's auto loan calculator to see how different down payment amounts, interest rates and loan terms affect your monthly payment and total financing costs.

Learn more: Car Loan Monthly Costs

How to Finance a Car

To finance a car, follow these steps:

1. Determine what you can afford. Take your income, expenses and current debt into account when deciding how much car you can afford. In addition to the sticker price, consider taxes and fees, and possibly warranties or maintenance contracts. You can typically roll these expenses into your auto loan to lower your upfront costs, but that means higher car payments.
2. Check your credit report and credit score. A higher credit score can help you qualify for lower interest rates. Check your score several months before shopping for loans so you have time to work on improving it if necessary. You can check your credit report and FICO^® Score^Θ for free with Experian.
3. Shop around. Although most auto dealers offer financing, you should explore your options before visiting the dealership. You can shop for auto loans from banks, credit unions, online auto lenders and online marketplaces, where you can compare offers from multiple lenders.
4. Get preapproved. Before heading to the dealership, apply for loan preapproval from multiple lenders to see which offers the best terms. You'll get a preapproval letter stating how much you can borrow and the interest rate. Do your rate shopping within a couple weeks to minimize impact to your credit.
5. Visit the dealership and choose your car. Bring your loan preapproval letter to boost your negotiating power. See if the dealer can beat that lender's loan terms.
6. Select the best loan option, finalize the loan and buy the car. Be sure to review your loan agreement carefully before signing it.

Tip: Applying for an auto loan causes a hard inquiry on your credit report, which can temporarily ding your credit score. Complete all your loan applications within a couple weeks, and credit scoring models will treat them as one inquiry, minimizing any negative impact on your credit.

Learn more: How to Get the Best Auto Loan Rate

What Credit Score Do I Need to Finance a Car?

There isn't one minimum credit score needed for an auto loan, since different lenders have different criteria for evaluating borrowers. Factors such as your debt-to-income ratio, employment and down payment amount can also impact your chances of approval. That said, having good credit (generally defined as a VantageScore^® credit score of 661 and up or a FICO^® Score of 670 and up) can qualify you for lower interest rates, more loan options and better terms.

If your credit is fair or even poor, it's still possible to get a car loan. However, you'll likely have more limited loan choices, and you may need to make a bigger down payment, pay higher interest rates or face other restrictions.

Learn more: Car Loan Scams and Red Flags to Look Out For

How to Finance a Car With Bad Credit

If you have bad credit (generally meaning a FICO^® Score under 580), you'll have fewer options for financing a car, but there are things you can do to improve your odds. Start by checking your credit report to identify potential areas for improvement. If you don't need to buy a car right away, taking these actions can help improve your credit score:

• Bring past-due accounts current and pay down high credit card balances.
• Set up autopay to help ensure future bill payments are made on time.
• Become an authorized user on the credit card of a family member with a good payment history.

Saving for a bigger down payment on a car reduces the amount you need to borrow. This lessens the lender's risk and could help you get approved for a loan.

You can also persuade someone with good credit to cosign on your loan. However, if you fail to make your payments, the cosigner will be responsible for repaying the loan, which could hurt your relationship.

Learn more: What Is the Lowest Credit Score to Buy a Car?

Frequently Asked Questions

The Bottom Line

Financing a car can help you buy a new vehicle without having to pay cash. There are plenty of ways to finance a car, and taking time to explore the possibilities can help you find an auto loan that fits your budget. You can check your FICO^® Score and Experian credit report for free before applying for a car loan to see where you stand.

If you have poor or fair credit, following tips to improve your credit score could expand your financing options. Consider signing up for Experian Boost^®ø, a free feature that adds on-time household bill payments to your Experian credit report, which could help improve your credit. Eligible payments may include utilities, insurance, rent, streaming services and cellphones.