How Buying a Car Actually Works: APR, Loan Term, Depreciation, Equity
Buying a car on credit is borrowing money to own a depreciating asset. The total cost is loan interest plus the depreciation you experience during ownership. Your equity at any point is the car’s current market value minus what you still owe. Understanding these mechanics is the foundation of the buy-vs-lease decision.
2026 APR tiers (new-car loans)
| Credit Tier | FICO Range | Avg New-Car APR | What it means |
|---|---|---|---|
| Super-prime | 781-850 | 4.66-5.25% | Lowest available, best terms |
| Prime | 661-780 | 6.89% | Standard qualified buyer |
| Near-prime | 601-660 | 9.83% | Higher rates, consider short term |
| Subprime | 501-600 | 13.18% | Very expensive; lease may be better |
| Deep subprime | under 501 | 16.01% | Buy vs lease math flips hard |
Source: Experian Q4 2025 data / Bankrate April 2026 averages. Credit unions typically 1 to 2% below bank rates.
Loan term economics
The loan term affects three things simultaneously: monthly payment, total interest paid, and how quickly you build positive equity. Longer terms lower the monthly payment but add significantly to total interest and keep you underwater (owing more than the car is worth) for longer. The following table uses a $37,000 loan at 6.89% APR:
| Term | Monthly Payment | Total Interest | Months Negative Equity |
|---|---|---|---|
| 36 mo | $1,130 | $3,680 | 6-10 |
| 48 mo | $881 | $4,888 | 10-16 |
| 60 mo | $730 | $6,180 | 16-24 |
| 72 mo | $624 | $9,028 | 24-36 |
| 84 mo | $551 | $10,884 | 36-48+ |
Depreciation curve
A typical mainstream new car loses approximately 20% of MSRP in year 1, 15% in year 2, 10% in each of years 3 through 5, and 7% per year from year 6 onward. On a $40,000 car, this implies:
| Year | Annual Depreciation | Estimated Market Value | % of MSRP Retained |
|---|---|---|---|
| 0 | - | $40,000 | 100% |
| 1 | $8,000 | $32,000 | 80% |
| 2 | $4,800 | $27,200 | 68% |
| 3 | $2,720 | $24,480 | 61% |
| 5 | $4,390 | $19,840 | 50% |
| 7 | $2,780 | $16,440 | 41% |
| 10 | $3,340 | $12,800 | 32% |
Illustrative example on $40,000 MSRP. Real depreciation varies by make, model, condition, and market.
When you hit positive equity
Positive equity means the car’s market value exceeds the remaining loan balance. How quickly you get there depends on loan term and down payment. With $3,000 down on a $40,000 vehicle ($37,000 financed at prime APR):
- 36-month loan: positive equity by month 12 to 18
- 60-month loan: positive equity typically by month 30 to 36
- 72-month loan: positive equity typically by month 42 to 48
- 84-month loan: positive equity frequently not until month 54 to 60
The 72 and 84-month loans keep you negative longer because payments are spread so thin that principal paydown barely keeps pace with depreciation. This is the “upside-down” trap: if you need to sell or trade at year 3 on a 72-month loan, you likely owe $3,000 to $7,000 more than the car is worth, which gets rolled into the next loan as negative equity.
2026 OBBBA loan-interest deduction
New for 2025-2028 (OBBBA Section 70606)
Up to $10,000 per year of auto loan interest is deductible above-the-line (no itemising required) for personal-use new vehicle purchases that are US-assembled with loans originated between 1 January 2025 and 31 December 2028. Income phase-out begins at $100,000 MAGI single / $200,000 joint.
Worked example. Prime buyer, $37,000 loan at 6.89% APR, 60-month term. Year 1 interest: approximately $2,430. At 24% marginal rate: $583 tax savings. Year 2: $2,070 interest, $497 savings. Over 5 years: approximately $1,650 total tax savings on $6,200 total interest paid.
Does NOT apply to: used-car loans, lease transactions, business vehicles (which deduct interest directly as a business expense), non-US-assembled vehicles (note: Canada and Mexico assembly qualifies under USMCA). EV-specific application →