How a Car Loan Works
Just the Tip:
A car loan’s cost comes down to the rate, the term, and how much you borrow. Line up offers at the same term, then compare each one’s APR, which counts fees as well as interest, and its total cost. Putting more down cuts both your payment and your interest, while stretching the term cuts the payment but adds interest.
Commercial banks charged an average 7.54% APR on 60-month new car loans in the third quarter of 2026, according to the Federal Reserve. At that rate, the interest over those 60 months comes to about a fifth of the amount borrowed.
The amount financed is the car’s price plus taxes, fees, and any add-ons you finance, minus your down payment, which can be cash, a trade-in, or both. The term is the length of the loan in months.
Most car loans charge simple interest, figured on the balance you still owe. Each payment goes first to any fees and interest due, and the rest pays down the balance, so the first payments carry the most interest and the last ones almost none. Spread the same loan over more months, and each payment shrinks, but you pay interest for longer.
Here are three versions of a $40,000 car loan at 7.54% with no fees.
- Borrowed over 60 months, the $40,000 costs about $802 a month and $8,140 in interest.
- With $8,000 more down, the $32,000 left costs about $642 a month and $6,510 in interest over the same 60 months.
- Stretched to 72 months, the full $40,000 costs about $692 a month and $9,850 in interest.
Stretching to 72 months lowers the payment by about $110 a month but adds about $1,700 in interest. The extra $8,000 down lowers both the payment and the interest, by about $160 a month and $1,600.
You can borrow from a bank, a credit union, or an online lender, or through the dealer’s finance office, which sends your application to several lenders and usually picks one offer to show you. Getting preapproved first gives you an offer to compare with the dealer’s.
Lenders and dealers must give you a Truth in Lending disclosure before you sign. It lists the APR, the amount financed, and the total of payments, which is every payment added together. At the same term and amount financed, the offer with the lowest total of payments is the cheapest loan.
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