How to calculate interest on a car loan
Interest on a car loan is the cost of borrowing money to buy a car. The lender will look at your credit score, debt-to-equity ratio, and other factors to determine the interest rate they offer.
To work out your budget, you need to know your rate and the monthly amount of your loan balance.
How does interest on a car loan work?
Most lenders use simple interest for auto loans. Interest is calculated based on the amount you owe – the principal – each month. As you pay off your loan, you’ll spend less on interest and more on principal. Interest is amortized or repaid evenly over the term of the loan.
Pre-calculated interest is less common and used on auto loans for borrowers with bad credit. The lender will calculate the total interest paid over the term of the loan. This total is added to the capital and divided between your monthly payments. Since interest is not amortized evenly, you will pay more interest at the start of your loan.
If you do not plan to repay your loan early, there is no difference between simple interest and pre-calculated interest. If you pay off your loan sooner, you’ll save more money with a simple interest car loan.
How to Calculate Car Loan Interest Payments
There are several ways to calculate the monthly interest payment for your car loan. You can use an online loan payment calculator or work directly with a lender. As long as you know the principal, loan term, and interest rate, you should be able to estimate your monthly payment – and the total interest you’ll pay.
Use an auto loan calculator.
Free online auto loan calculators let you skip the pencil and paper and instantly determine your interest payment. 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 based on your down payment and how much you need to borrow.
Factors That Determine Auto Loan Interest Rates
To get an idea of the interest rates available to you, you can prequalify with several lenders. You must prequalify with at least three before going to a car dealership. Your auto loan rate is determined by factors such as:
- Credit score. Lenders weigh heavily on your credit score when they set your rates. The lower your score, the higher your rate. According to data from Experian, the average rate for someone with excellent credit buying a new car was 2.96% in 2022. People with bad credit paid significantly more – with an average interest rate of 12.84%.
- Debt to income ratio. A lower DTI can mean a better rate because lenders will consider you less at risk of default.
- 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. If you’re looking to buy a car that’s over 10 years old, you may find it difficult to find car financing at a reasonable interest 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 help you 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 annual percentage rate of charge. The APR includes both interest and lender fees, expressed as a percentage.
Knowing each lender’s APR can help you find the auto loan with the lowest overall cost. The interest rate shown on the main page is probably just the starting rate. You’ll likely need excellent credit of 740 or more and a stable income to get this low rate.
Dealerships make it easy to buy and finance in one place. But often a dealer won’t provide the best interest rate. Instead, get pre-approved from a few direct lenders first so you can negotiate like a cash buyer.
You should also review the lender’s requirements and restrictions. You can check them on the lender’s website or by using their quote form or app. You can also check reviews.
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. A larger down payment can be more profitable than a long-term loan because you’ll have smaller principal and pay less interest over time.
Experts often recommend putting at least 20% less, but that’s not a strict requirement in most cases. Because new and used car prices have risen, the average down payment is over $6,000 in 2022, according to Edmunds.
The bottom line
Interest is the main cost of taking out a car loan. When you’re ready to buy, get pre-approved from multiple lenders and use auto loan calculators to figure out how much you’ll pay. You can make an informed decision and avoid paying more interest than you should.