How Do Car Payments Work

Updated on April 8, 2024

At a Glance

  • Crucial to understand car payments when buying a car.
  • Monthly payment influenced by loan amount, APR, and loan term.
  • Lower monthly payments may result in more interest with longer loan terms.
  • Determine budget, check credit report, consider cosigner if needed.

As a visa holder, you might be wondering, “How do car payments work in the U.S?” If you are considering buying a car, it is important to understand the question of how car loans work as it will influence your choice on how you finance your car.

Below we explain how car payments work and also give you some guidelines on your financing options.

Understanding How Car Payments Work

If you are considering buying a car it is important to understand how car loans work.

Lower monthly payments usually sound like a good idea. Sure, you have more cash flow available, but paying less per month it is not always financially beneficial. It is important to understand what determines your monthly payment and what it means for your finances.

Three Factors that Affect Car Payments

The three factors that affect your car payment are:

  1. The loan amount

The higher your loan amount, the higher your monthly payment. If you make a substantial down payment, this will lower your loan amount and your monthly payments.

  1. The APR (Annual Percentage Rate)

Loans with higher APR’s have higher monthly payments.

  1. The loan term

This is the period over which you repay the loan. Extending your payment term will lower your monthly payments, but remember that it will probably end up costing you more in the long run as you will be paying interest over a longer period of time.

Lower Monthly Payments Can Cost More

Longer loan terms mean lower monthly payments. It is easy to assume that lower monthly payments are a financial benefit. Don’t forget that a longer loan term is equal to paying more interest.

If you take out a loan of $25,000 with a 3% APR over 4 years you will pay total interest of $1,561 on the loan. If you pay off the same amount with the same APR over 5 years, you’ll be paying $104 less per month. but you’ll end up paying $1,953 total interest.

The same interest percentage accrues over a longer period, which means you end up paying more in the long run.

Before you Lease or Buy a Car

Before you make the decision between financing or leasing a car (whether it’s a student car lease or international student auto loan), there are important factors that you need to take into account.

The three most important factors are:

  • Determining your budget
  • Getting a copy of your credit score
  • Figure out if you have a cosigner

Determine Your Budget

Determining your budget means you have to determine how much you can afford. It is important to always be able to cover your basic monthly expenses before you have to make any payment towards a car.

You should only finance or lease a car if you can really afford to take on a new monthly payment. If your budget is limited, it might be a good idea to try and save towards a bigger down payment or to consider trading in your car. This will bring down your financing or leasing cost.

So should you trade in? Doing a trade in can sometimes serve as the “down payment” for your new car. This will not work, however, if you still owe money on your car.

If you owe more on your car than your car is worth, it is called negative equity. Take a look at this page to learn more about negative equity and how it can influence the financing of your new car. You might want to consider first paying your outstanding debt on your car before you choose to buy or lease a new car.

Obtain a Copy of Your Credit Report

It’s always a good idea to get a copy of your credit report before you make a major purchase or financing decision.

You can get a free credit report from TransUnion, Experian, and Equifax – or on a website like You can also pay one of the credit bureaus to get your actual accurate credit score.

You will be able to get a free credit report every twelve months from each of the nationwide reporting agencies.

Your credit report will give you an idea of how lenders view you, i.e. how much of a risk do they regard to them? This will give you an indication of the type of interest rates you will be offered.

Figure Out if You Have a Cosigner

If your credit report turns out to not be that great, lenders may require that you have a cosigner on the lease agreement or loan agreement. Lenders require cosigners as they absorb some of the risks in lending you money. As the cosigner is equally responsible for paying any amounts due, lenders can claim outstanding payments from the cosigner.

Even if your lender doesn’t require a cosigner, having a cosigner might be beneficial if you don’t have a good credit score. As cosigners lessen the risk for lenders, you might be able to get a more favorable rate if you make use of a cosigner.

Should I Use Financing?

If you are considering financing to buy your car, make sure that you:

  1. Know your financing options, and
  2. Find the best financing deal.

Know your Financing Options

When financing a car, you basically have two options:

  1. Direct Lending
  2. Dealership Financing

Direct Lending

Direct lending means you borrow money directly from a bank, credit union or other financing company. You take out a loan and agree to pay back the loan amount plus interest and finance charges over a certain period of time. You use the loan amount (which is a lump sum of money) to buy the car you need.

If you want to use this type of financing it is a good idea to shop around and compare several lenders and their credit terms before you decide which car you want to buy. You can also get your credit terms in advance by going for a loan pre-approval before you purchase the actual car.

Dealership Financing

Many car dealerships also offer financing to purchase a car. With dealer financing, you buy a car from a specific dealer and agree to pay the amount of the car off at that dealer instead of taking out a loan for the amount and paying off the loan amount with the lender. So basically the dealership lends you the money and will act as your lender. Finance charges and a specific loan and repayment terms apply to dealer financing as well.

There could be some perks to rather making use of dealership financing. First of all, it is convenient. You only have to deal with one entity when buying the car and getting the financing. Dealers also have relationships with various banks and credit institutions, so they might be able to offer you a wide variety of financing options.

Find the Best Financing Deal

Whether you choose direct lending or dealership financing, shopping around for the best financing and car deal is essential. Also don’t be shy to negotiate the terms they offer you. Comparison shopping enables you to find the best finance terms and car that best suit your individual needs.

When doing comparisons, make sure you understand the various terms, conditions, and cost involved in each deal. Remember that the total amount you will pay in the end depends on the amount of financing (i.e. the price of the car), the APR and the loan term.

Deal Financing

If you choose to go with dealer financing, your process will look more or less as follows:

The dealer will have a Finance and Insurance (F&I) Department. This department will tell you about the financing options that are available to you. You will be required to fill in a credit application form.

The credit application form will probably require the following information:

  • Full names and surname
  • SSN (social security number)
  • Date of birth
  • Current and previous employers
  • Length of employment at each
  • Current and previous addresses
  • Length of stay at each address
  • Whether you are employed and what you do
  • What are your sources of income
  • Your total gross monthly income
  • Financial information about current credit accounts.

The dealer will look at your credit report and credit score to get information about your present and past credit agreements and payment history.

When you are negotiating with the dealer make sure you ask them about manufacturer incentives. Some dealers offer reduced finance rates or cash backs on certain car makes or models.

It will also be worth it to ask if you qualify for any rebates or special discounts. The dealer will have to explain to you exactly what is required to get these incentives. If you qualify for an incentive, make sure to look closely at the restrictions that apply and don’t assume the rebates that do apply have already been included in the price offered to you.

Finally, make sure you understand all the terms and conditions before you sign your financing contract. Don’t sign the contract until your financing has been fully approved.

Should I Lease a Car

If you need a car but you’re not sure that you want to buy one, you can consider leasing a car. When you lease a car you enter into an agreement to use someone else’s car for a specific number of months and miles.

How Does Leasing Differ from Buying?

Your monthly payments with a lease are usually lower than when buying for the exact same car. Essentially you are paying for the car’s depreciation during the period that you lease it plus some rent, tax, and fees. At the end of the lease, you have to return the car to the owner, unless your agreement gives you the option to buy the car.

What Should I Consider When Looking at a Lease?

The most important factor is the mileage limit. This puts a limit on how much you are allowed to drive. Most leases offer a mileage limit of 15,000 miles or less per year. You can get a higher mileage limit, but this will increase your monthly payments as the car will be depreciating more during that period. If you accidentally drive over your mileage limit, you will have to pay an additional charge when you return the car.

You also need to consider the terms of the lease. Most leases require you to be responsible for wear and tear and damages to the car, as well as any missing equipment. You’ll have to service the car according to the manufacturer’s recommendations and you’ll have to take out insurance which is up to the required standard.

If you might move during the period you lease the car or you plan on taking a holiday, make sure you are allowed to take the car outside the state you are in. Most leases don’t allow the vehicle to move beyond state borders.

Is Leasing the Right Choice for Me?

To determine if leasing a car is the right choice for you, you can ask yourself the following questions:

  1. How long do you want to keep the car?
  2. How much will you drive on average during the year?
  3. Do I only need the car for this year or on the longer term?
  4. Is there a chance I’ll be moving beyond state borders?

Consider your answers to these questions in light of the information we gave you above. Maybe leasing a car is the right choice for you!

What Happens after Signing

You’ve signed your lease or credit agreement. What now?

Make sure you take a copy of the agreement with all the signatures and terms filled in. Don’t leave it until later to pick up a copy, as the documents might get misplaced and then you have no proof of what you agreed to.

If you chose to finance your car, remember that the lender has a lien on the car (and sometimes also reserves ownership) until you have paid the car in full.

The most important thing to do is to make all your payments on time. If you don’t, you might end up with additional fees being charged or your car can even be repossessed. If you miss a payment, it will definitely have a negative impact on your credit report.


Buying a car is a big decision, so it is important to understand the question of how do car payments work and all the factors surrounding your repayments and financing. Sometimes it’s all about cash flow and you might have to factor a higher total amount into your future to afford a car now, but don’t sacrifice your future wealth unnecessarily. Make sure you shop around for the best deal that suits your individual needs and don’t just fall into the trap of low monthly payments but a higher total cost in the end for no reason.

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Frank Gogol

I’m a firm believer that information is the key to financial freedom. On the Stilt Blog, I write about the complex topics — like finance, immigration, and technology — to help immigrants make the most of their lives in the U.S. Our content and brand have been featured in Forbes, TechCrunch, VentureBeat, and more.

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