From your bank or credit union to online lenders and even dealerships, different types of auto loans are widely available and accessible, even if your credit needs work.
However, choosing between various types of auto loans can get complicated. Your loan type could vary by the age of your car and where you’re buying it, or by personal factors like being a first-time buyer, lease-holder, business owner or military member.
Also, whether you’re buying or refinancing, be aware that different auto loans can be secured or unsecured, offered by direct or indirect lenders, and use a simple or precomputed interest rate formula.
10 types of auto loans for buying a car
10 types of auto loans for buying a car
| Type |
|---|
1. New car purchase |
1. New car purchase loans
This common type of auto loan is designed to purchase a new vehicle or one that’s no older than a couple of years and has never been titled. These loans tend to have the lowest interest rates because the vehicle’s high collateral value means less risk for the lender. You can get these loans directly from a lender or indirectly through a dealership.
Good to know: The best auto lenders typically offer lower rates than you can find at the dealership, but if you have excellent credit and want to buy a popular model, you may snag a low or 0% APR promotional deal from the automaker.
2. Used or pre-owned car loans
These loans are designed to purchase used vehicles and often have slightly higher interest rates than new car loans because of the vehicle’s depreciated value. You can get these loans directly from a lender or indirectly through a dealership.
Most lenders place restrictions on the age and mileage of the vehicles they’re willing to finance, commonly 10 years and 100,000 miles. Finding a lender to finance classic or high-mileage cars can be challenging, though some lenders offer specialized products to fill that need.
3. First-time car buyer loans
Some dealers may offer loans specifically for first-time buyers without prior purchasing experience. These loans are designed to accommodate buyers whose credit history is lacking; they feature more flexible credit, borrowing and down payment requirements. They may even offer special discounts for recent college graduates. However, expect to pay higher rates than you would with a traditional loan.
Related >> Can you buy a car with no down payment?
4. Lease buyout loans
This auto loan enables you to purchase your leased vehicle at the end of the lease term. It effectively converts your lease agreement into a purchase agreement so you can continue making a fixed monthly payment toward the purchase of the vehicle, said Brandon Williams, CEO of lease buyout platform Lease End.
“Auto lease buyout loans can be a great option for consumers who have grown attached to their leased vehicle or want to avoid the hassle of shopping for a new car,” said Williams. “Sometimes, the car’s value exceeds the buyout price, making the deal an even bigger win for the lessee.”
Related >> Should you lease or buy?
5. Private-party auto loans
They’re useful if you’re buying a car from a private seller rather than a dealership — and need to finance the purchase. Not all lenders offer this type of auto loan, and rates are usually higher than they would be with a traditional loan. (Some lenders allow you to use a traditional used car loan to purchase from a private seller.)
6. Balloon auto loans
These loans give you a lower monthly payment for most of the loan term and then require a large final payment at the end. (They’re structurally similar to a lease agreement but are intended for purchasing, not leasing, a vehicle.) These loans aren’t very common because they pose a high degree of risk to the lender.
Bottom line: These loans aren’t a good idea unless you’re certain you can afford the final payment, which can be more than half the cost of the vehicle.
7. Business auto loans
If you run your own outfit, business auto loans can help you finance company cars. They also allow you to take advantage of tax deductions for business costs, but you’ll need to prove to the lender that the vehicle is for business purposes.
Some lenders may even offer qualified businesses lines of credit to purchase multiple (perhaps a fleet of) vehicles. There’s also equipment financing if you want a business loan to buy multiple company cars or heavy-duty or commercial vehicles.
8. Military auto loans
This type of car loan caters to active-duty service members, veterans and their families. It includes special protections for service members awarded under the Military Lending Act and the Servicemembers Civil Relief Act, including interest rate caps and safeguards against repossession and default judgments. They may also include special discounts.
9. Buy-here-pay-here auto loans
Some dealers offer these loans, also known as “no credit check” or guaranteed loans.
These non-brand name dealerships (typically with flashy, all-caps advertising) tend to sell low-value vehicles and target buyers with bad credit. They decide how much they’re willing to lend without considering conventional credit factors and charge much higher interest rates and fees than you’d get with a traditional loan. They may be guiltier of even shadier practices, too, such as installing tracking devices or kill-engine switches on their cards.
Bottom line: This product isn’t a good option since it raises the risk of being “upside down” on the loan, or owing more than the car’s worth. And buy-here-pay-here lenders typically don’t report your loan payments to credit bureaus, so they won’t help you improve your credit. Even if you have especially poor credit, you’ll likely have better options, such as finding a creditworthy cosigner to strengthen your application for another type of auto loan.
10. Title loans
Another type of auto loan to avoid, if possible: This one allows you to borrow against your vehicle equity in exchange for using the title as collateral. These short-term, high-interest loans may give you fast access to cash but come with steep costs. Notably, there’s a high risk of repossession, as you must pay back what you borrow plus a high amount of interest in a short period, usually within 30 days.
Many states don’t allow these loans, and those that do usually require you to fully own a car to borrow against it.
Bottom line: A small personal loan or credit card may be a better option for those looking to access cash for an unexpected expense. Like all forms of borrowing, however, don’t take out a loan or charge the plastic in your wallet without a realistic plan for repayment.
2 types of auto loans for refinancing
1. Car refinancing loans
Refinance loans pay off and replace your existing loan and are often used to get a better interest rate or reset the loan term. You might end up with either lower monthly payments or overall costs, depending on whether you’re extending or shortening the term. Like most auto loans, these tend to be secured loans that use your vehicle as collateral.
Related: When can you refinance?
Refinancing your car loan can bring many benefits, like lower interest rates, monthly payments and overall costs, but beware of fraudulent offers and loan modification scams. You might start by getting preapproved with your current lender and examining top competitors to secure the best auto refinance rates available.
Tip: Use a free online loan repayment calculator (like Calculator.net’s) for your current and potential new loan to understand whether the cost of refinancing is worth the potential savings.
2. Cash-out car refinancing loans
Cash-out refinancing loans allow you to borrow more than you owe on your vehicle — and pocket the difference. You essentially replace your existing loan with a new one for a larger amount.
These loans can be a good way to come up with fast cash, but they raise the risk of being upside down on your car loan, given that vehicles quickly depreciate.
Types of auto loans: Secured vs. unsecured
Most auto loans are secured loans. This means they’re backed by collateral, typically the vehicle being purchased (or refinanced). So if you default on the loan, the lender can seize the vehicle to recoup its losses.
Unsecured loans don’t require collateral. Lenders consider these loans to be riskier, usually have tighter credit requirements and charge higher interest rates. If you want to use an unsecured loan to buy a vehicle, you’ll likely need to take out a personal loan.
Pros and cons of secured auto loans
| Pros | Cons |
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Lenders view secured loans as less risky, so they tend to have lower interest rates and better terms. That can make secured loans more accessible if you need wheels but have poor or thin credit.
But keep in mind that older or high-mileage vehicles may not qualify for a secured loan. The vehicle may need to meet specific eligibility requirements. Also, unlike with personal loans, you won’t have any flexibility with how the loan funds are used, and the funds are typically disbursed directly to the dealer.
Pros and cons of unsecured auto loans
| Pros | Cons |
|---|---|
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Unsecured loans give you the peace of mind that the vehicle won’t be repossessed if you fail to pay. Since these are personal loans, there are no restrictions on the kind of vehicle you buy or refinance, or how you use the funds. The application process can be simpler, too, since you don’t need to navigate as many lender requirements.
But you’ll likely pay more in interest, which means higher monthly and overall cost. In fact, in late 2023, the average rate on a five-year auto loan was 8.15%, while the average rate on a personal loan was 12.35%.
Credit requirements are often more strict than they would be with a secured loan since there is more risk to the lender, and rates may be higher. And while you avoid the risk of your vehicle being repossessed, your credit score will still suffer if you fail to repay the loan.
Direct auto financing vs. indirect auto financing
Direct auto financing means working directly with a bank, credit union or other lender to take out an auto loan. You can shop around with multiple lenders and get preapproved to ensure you’re getting the best possible offer, but this may mean doing a bit of legwork before purchasing your vehicle.
Indirect auto financing refers to a dealership (or online loan marketplace) arranging or originating your financing. This can simplify the overall car-buying process. Plus, if you have a strong application, you could get access to special financing offers, such as a 0% introductory APR. Alternatively, if your credit scores need work, the dealer may partner with lenders that provide bad-credit car loans.
Bottom line: Odds are you’ll pay more in interest and fees with indirect financing; look at it as a convenience fee, and a potentially pricey one at that. Before accepting an indirect financing option, ask the dealer what other offers it received so you can be sure you’re getting the best option. Better yet, compare those offers to direct auto financing options you received independently.
| Direct financing | Indirect financing | |
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Types of interest on auto loans: Simple vs. precomputed
Most auto loans charge simple interest, while the interest on others may be precomputed.
Simple interest is calculated each billing cycle as a percentage of the principal balance. If you pay more than the minimum, the extra funds are applied to the principal and you’ll repay the loan more quickly.
Precomputed interest, also called “Rule of 78” interest, refers to the loan’s overall interest being tacked onto your principal when you begin repayment. This interest becomes part of what you owe regardless of whether you make additional payments toward the principal.
Bottom line: If you aim to pay off your debt early, prioritize an auto loan that uses a simple interest formula. While it may be possible to get a rebate on “unearned” interest on a precomputed loan that’s paid off early, the savings from paying off a simple-interest loan early are greater.
Example: Let’s say you take out a $25,000 auto loan with a 7% interest rate and a five-year term. Your monthly payment is $495. Your total interest charges for the life of the loan would be $4,702, meaning you’ll pay a total of $29,702 for the vehicle.
With simple interest, your first payment would cover $146 in interest and $349 would go toward the principal. As you continue to make payments, the amount allocated for interest shrinks and the amount paying down your principal grows (this is known as amortization). By the start of year two, your payment allocation is $121 to interest and $374 to the principal.
| Month of repayment | Interest | Principal | Ending balance |
|---|---|---|---|
| 1 | $146 | $349 | $24,651 |
| 13 | $121 | $374 | $20,298 |
| 25 | $95 | $402 | $15,631 |
| 37 | $65 | $431 | $10,626 |
| 49 | $33 | $462 | $5,259 |
| 60 | $3 | $492 | $0 |
If you pay an additional $100 toward your principal each month under the simple interest model, you would shorten the length of the loan by 11 months and save $939 in interest. (Before you attempt an early payoff, ask your lender about its prepayment penalties, if applicable.)
How to choose the best auto loan for your needs
Before you take out an auto loan, take stock of your needs and determine what you can afford. Then, determine which type of loan is best for your situation. Consider this checklist when evaluating your loan options.
- How’s your credit? Like with other financial products, all reputable types of auto loans involve a credit check. Review your credit reports for free via AnnualCreditReport.com — and improve your scores — to ensure you get the best auto loan rates for your credit score range.
- Where is the loan coming from? Is it a direct loan from a lender or an indirect loan through the dealer or other third party? An indirect loan through the dealer may be more convenient, but you’ll likely get a better deal working directly with a lender.
- What are the overall loan costs? When comparing loan offers, take full stock of the total costs. Check the annual percentage rates, or APRs, for an apples-to-apples cost comparison. After all, APR accounts for the interest rate and the lender’s fees. One lender might offer a lower interest rate but a higher APR than competing lenders.
- How is the interest calculated? It’s crucial to know whether your loan uses the simple or precomputed interest method. If you want to be able to save money in the long run by paying more than the minimum monthly payment, choose a simple interest loan.
- Will you become “upside down” on the loan? Fully understand the risks of borrowing auto loans, especially if you’re refinancing or pursuing options for bad-credit borrowers, like a buy-here-pay-here loan. You can easily end up owing more than the value of the vehicle.
- Do you qualify for special loan options? If you’re in the military community, run a small business or are a recent college graduate, there may be special loan options available to you.
Tip: Use your lowest loan offer to negotiate with other lenders (especially your dealer, if applicable) to see if they’ll match or beat it. Don’t feel bad about negotiating — it’s a common practice in the auto loan industry.
Frequently asked questions (FAQs)
Secured auto loans, which are the most common, require collateral, usually the vehicle being purchased. If you default, the lender can repossess your vehicle to recoup its losses. Unsecured loans don’t require collateral, but usually have higher interest rates and stricter credit requirements.
The most important things to consider are whether you can afford the monthly payment and the total cost of financing. Other key considerations include whether the loan is secured or unsecured; how the interest is calculated; whether you’re eligible for any special loan options like military or business auto loans; and the risk of becoming upside down on the debt.
With direct auto financing, you work directly with a lender to get a car loan. With indirect auto financing, a dealership or other third party seeks loan offers on your behalf and often adds a markup to the interest rate.
New car purchase loans are designed for the purchase of new vehicles and typically come with lower interest rates. Loans for the purchase of a used car may have higher interest rates since the value of the vehicle, which also serves as collateral for the lender, has depreciated.
