Interest on a car loan is the cost of borrowing money to buy a car. Auto loan interest rates are expressed as a percentage. When expressed in APR (Annual Percentage Rate), it includes all lender fees, including loan origination fees, loan setup fees, and commission.
Interest is calculated taking into account a few factors. The bank will look at your credit score and debt-to-equity ratio, along with other factors, to determine the interest rate they offer you. Essentially, the less creditworthy you are, the higher your interest rate will be.
How to Calculate Car Loan Interest Payments
There are several ways to calculate the monthly interest payment for your car loan. You can calculate it yourself or use an online loan repayment calculator, or work directly with a loan officer.
Calculate the car loan interest payment yourself
To get started, find the amount, interest rate and term of your car loan. The term can range from 24 months to 84 months, but the longer you take, the more interest you will pay. The lender will also consider your down payment and the amount you are borrowing.
Using this information, you can then calculate the amount of your monthly interest payments. Since a car loan is amortized – like student loans and mortgages – it’s a bit more complex than just calculating interest. You will first need to divide your interest rate by the number of payments you make in a year, probably 12. Then you will take that number and multiply it by the loan balance.
To get the monthly interest payment on a $25,000 loan with an interest rate of 4% with monthly installments, you would take 4% expressed as a decimal (0.04) and divide it by 12, then multiply the profit by 25,000. This amounts to an interest payment of $83 for your first month. To get the next month’s interest payment, you must repeat the process with the new loan balance.
Use a car loan calculator
You can go further by using an auto loan calculator. These calculators allow you to find the monthly payment with different interest rates and loan conditions. The Bankrate Auto Loan Calculator will also provide a full amortization schedule so you can see how much interest you are paying each month and the total interest paid over the life of the loan.
Speak directly to a lender
You can also speak directly to a lender to compare potential rates. Working with a loan officer means you can get a personalized idea of what your loan might look like, including potential interest rates.
Factors That Determine Auto Loan Interest Rates
To get an idea of the interest rates available to you, you can prequalify with several lenders. It is recommended that you prequalify with at least three before heading to a car dealership. Your auto loan rate is determined by a number of factors, including:
- Credit score. Banks and lenders have systems in place to determine your creditworthiness and set your rates. The lower your score, the higher your rate.
- Term of the loan. Generally, longer loan terms lead to higher rates. It also means a higher amount paid over the term of the loan, but may result in lower monthly payments.
- Advance payment. Making a large down payment means you borrow less and are less likely to lose your loan.
- Age of the car. Generally, the older the car, the higher the rate.
- Work and education experience. Some lenders now take your work history and education into account when determining your interest rate, which means you could qualify for a decent rate without having the best credit score.
How to avoid paying too much interest
With the right strategy, you can pay less interest. Here are some tips to keep in mind to save money:
Shop for the best deal
As with other types of loans, the overall cost of a car loan comes down to one major factor: the APR. Knowing each lender’s APR can help you find the auto loan with the lowest overall cost.
Don’t just focus on numbers, though. Look at the lender’s requirements and restrictions too. You can check this on the lender’s website or by using their quote form or app. You can also check reviews.
Remember that the interest rate shown on the main page is probably the starting rate. To get this low rate, you’ll likely need excellent credit of 740 or more and a stable income.
Save before you buy
If you have some extra cash, you can use it as a down payment on your vehicle, which will lower your monthly payment and interest charges. Although it may seem counter-intuitive, a larger down payment can be more profitable than a long-term loan, as you will pay less principal and therefore less interest over time.
It is generally recommended to put at least 20% less, but this is not a strict requirement in most cases.
Don’t just check with the dealer
Dealerships make it easy to buy and finance in one place. But often a dealer won’t provide the best interest rate.
Get pre-approved from direct lenders before going to a dealership to ensure you get the best rate available. Plus, a pre-approval offer allows you to trade like a cash buyer.
The bottom line
Auto loan interest rates are based on several factors, including your credit score, loan term, down payment, vehicle age, and interest rate. Look at what you’ll pay in interest for different amounts, terms and rates before you take out a loan. This will help you make an informed decision and avoid paying more interest than you should.