Simply put, car loan amortization is the total repayment of your car loan over time. It’s calculated by dividing the loan amount by the number of months in the loan agreement.
This results in a specific amount that is due each month. Car loan amortization also includes interest and any fees, so the total cost of the loan will be higher than the principal amount. Auto loans can include simple interest or precomputed interest, depending on which type of loan you’ve agreed to with your lender (you can always ask them if you’re not sure).
Your monthly payment is determined based on the total loan amount, interest rate and term of the loan. But you might not realize that within that payment, a portion is applied toward both the principal (the borrowed amount) and the interest.
Amortization schedules can be confusing, but understanding how they work can save you money on your car loan. Here’s a quick overview of what they are and how to make them work for you.
Principal and Interest
The initial amount of money you borrowed is called the principal. The interest is what a lender charges you to borrow the money, plus any additional fees. Your monthly payment is divided between these two things based on an amortization schedule.
The amount of interest charged is based on the interest rate, which is set by the lender. There are generally industry trends for finance rates that can be easily tracked.
The greater the interest rate, the more you’ll pay in interest throughout the term of the loan. This is why it’s essential to secure the best auto loan financing possible for your credit score and situation, including a low interest rate.
Amortization Schedule
The amortization schedule is a table that shows how much of each payment goes toward the principal and how much goes toward the interest. In the early years of your loan, most of your payment will go toward paying off the interest. But as you get closer to the end of your loan term, more and more of your payment will go toward the principal.
Paying extra toward the principal can save you money in interest charges and help you pay off your loan faster. If you want to do this, just let your lender know how much extra you want to pay each month and they’ll apply it to your loan accordingly.
Short- and Long-Term Car Loan Amortization
It’s good to understand that you can select the term length for your car loan. The most common are 36, 48 or 60 months. However, some companies offer loans lasting as little as 12 months, although others extend as far as 84 months.
Choosing a shorter loan term will result in higher monthly payments, meaning you won’t be able to afford the same car as you would with a longer loan. But it also means you’ll pay less interest and pay off your loan faster.
A longer loan term will lower monthly payments, allowing you to afford a more expensive car. But you’ll also pay more interest over time, and it will take longer to repay your loan.
This is a decision that each borrower will have to make based on their budget and financial goals.
Changing Circumstances
Many people choose to use long-term loans because they lower monthly payments. But what happens if your circumstances change and you can afford to pay off your vehicle loan more quickly, or you simply want to get rid of it as soon as possible?
If you find yourself in this situation, you can always make additional payments toward your loan’s principal. This will reduce the interest you pay over time and help you repay your loan faster. Just be sure to check with your lender first to make sure there are no prepayment penalties.
Here are some common ways people pay off their car loans early:
Refinance – You can refinance your car loan to get a lower interest rate, saving you money over time. You can also choose to extend or shorten the term of your loan, depending on your current needs. Use a refinance car loan calculator to determine how much you could save.
Make a lump-sum payment – If you come into some extra money, you can make a one-time payment toward your loan’s principal. This will reduce the interest you pay over time and help you pay off your loan faster.
Pay extra each month – You can also choose to make slightly larger payments each month, which will go toward the principal of your loan. Just be sure to let your lender know that you want the extra payment to go toward the principal — not the interest.
You might not ever need to use any of these, but it helps to be aware of them in case you end up in a situation where you need to pay off your car loan faster.
How Understanding Car Loan Amortization Can Help
Car loan amortization is the process of repaying your car loan over time. The amount you owe each month is divided between the principal and the interest, and the schedule is set by the lender. You can choose a shorter or longer loan term, depending on what you can afford.
Understanding how car loan amortization works can help you save money and repay your loan faster. Be sure to ask your lender about their amortization schedule so that you can make the most informed decision possible.
Buying a car is a significant financial commitment. In fact, car loans are the second largest financial commitment most people will make (the first being a home mortgage). Learning how to calculate interest on a car loan will help you sift through your options and choose the loan terms that are best for you and your budget.
The Elements of a Car Loan
When calculating how much interest you’ll pay on your car loan, you’ll need three pieces of information:
Amount of loan: Whether you are seeking a new loan or refinancing your existing car loan, you will need to know the exact amount that you will be financing, including the price of the vehicle and taxes, as well as any add-ons that you’ve chosen, such as a GAP waiver.
Your interest rate: When you apply for an auto loan, your lender will use information from your application to determine your interest rate. Interest rates depend on several factors, including economic conditions, as well as your credit score, income and the age of the car that you purchase. Some lenders use other criteria in determining your rate, which could include your educational background and work history.
Length of repayment: You’ll need to know the length of your repayment period. Auto loan terms are expressed in months instead of years, and auto loan terms typically range from 24 to 84 months, though other terms might be available.
Calculating Your Monthly Interest Payments
Car loans are amortized, which means that you’ll be paying your loan balance off in installments. This means that the interest you pay over the duration of your loan will be based on an ever-declining principal balance. Because your principal balance changes each month, so will the amount of your interest payment.
If you want to know what you are paying in interest each month, you’ll need to do the following:
Begin with a straightforward calculation: Your interest rate (percentage) divided by how many payments you’ll make on the loan annually.
When you have that number, multiply it by your loan’s balance.
This calculation will give you the amount of interest you’ll be paying each month. It’s important to note that this number reflects only the amount of interest you’ll pay that month. This will change each month during the duration of your loan repayment period.
Another thing to remember is that your monthly interest payment is only one portion of your monthly car loan payment. The other portion is what you are paying against the loan balance.
If you aren’t a numbers person and all this seems too complicated, you can check out the AUTOPAY refinance car loan calculator to get a quick calculation, plus your estimated savings if you opt to refinance at a lower rate.
Other Factors That Determine Affordability
If you’ve run these numbers and are experiencing a bit of “sticker shock” at how much interest you are (or will be) paying each month, keep these things in mind:
As you pay down your loan, the percentage of each payment that goes toward interest decreases over time. This is because the amount of interest you pay is based on your loan balance. As the balance shrinks, so does the interest.
There are things you can do to reduce the amount of interest you’ll pay on a loan. These include improving your credit score by making timely payments and paying down existing debt, buying a new car instead of a used vehicle and, if necessary, finding a co-signer for your loan.
The larger your down payment on a vehicle, the smaller your balance will be. This can significantly reduce your interest payments.
Taking out a car loan or refinancing an existing loan can be a challenge, particularly when it comes to understanding your total costs. Make sure to shop around to get the loan you need with terms that you can afford.
Nobody disputes that spouses should make major financial decisions — such as purchasing a car or refinancing an auto loan — together. A more complicated question is whether spouses should be on a car loan as cosigners. Although having a spouse cosign on your car loan might make sense in some instances, it can be a risky personal and financial move in others.
What Is a Cosigner?
A cosigner agrees to pay a loan if the primary borrower defaults. When someone cosigns a loan, they assume responsibility for making loan payments if the original borrower falls behind on repaying the debt. Once the primary borrower defaults on payments, the cosigner is responsible for paying the balance of the loan, along with any fees related to the late payments. Also, the lender now treats the cosigner as the debtor.
Cosigner vs. Co-Borrower
Cosigners are not quite the same as co-borrowers. Co-borrowers apply for a loan together so that they can purchase (or refinance) an asset that they both own and use. When a married couple takes out a mortgage on a home that they both live in and own, they are co-borrowers.
A cosigner, on the other hand, assumes responsibility for paying someone else’s loan. The cosigner does not co-own the asset that the loan was used to purchase.
Why Do People Need Cosigners for Loans?
Lenders evaluate loan applications using multiple criteria, including income, credit history and current debt. If a loan applicant has poor credit, no credit, doesn’t earn very much or is struggling under a lot of debt, the lender might reject the application outright, offer a smaller loan or a loan at a higher interest rate. Sometimes a lender might ask that the borrower reduce the lender’s risk by finding a cosigner.
The Risks of Being a Cosigner
The risks of being a cosigner are significant. If you cosign a debt, and the original borrower doesn’t make payments on time, here’s what can happen:
The lender can require you to start making payments on the debt.
The lender can initiate collection proceedings against you, including a lawsuit.
Your credit score can be damaged.
In addition, cosigning a loan increases your debt load, impacting your credit score. This affects your ability to obtain a credit card, take out a loan for your own needs or qualify for good interest rates on goods and services. Because of these risks, you might want to check out other alternatives that can help you buy a car or refinance a car loan.
Spouses as Cosigners: What You Need to Know
Having your spouse as a cosigner might seem counterintuitive: You share finances and will both benefit from an automobile purchase or refinancing. Co-borrowing might make more sense, as would having the spouse with the best credit apply for the loan.
In some households, however, only one spouse drives and will have ownership of the car. Many people owned a car before getting married and could want to refinance that vehicle without putting their spouse on the title. In these cases, cosigning might make some sense.
As you make your decision, be aware that some lenders might tell you that your spouse is required to cosign a loan that you take out for your own vehicle. The federal Consumer Financial Protection Bureau makes it clear, however, that although a lender can require you to have a cosigner, it cannot require that person to be your spouse.
The Risks of Cosigning for a Spouse
There are significant risks to being a cosigner of a loan. These risks increase when a spouse acts as a cosigner. Cosigning impacts a spouse’s credit and finances, so your household might not have at least one spouse with pristine credit and financial stability. Should you face unexpected financial difficulties, your household will have to manage the debt that your spouse is obligated to pay.
Cosigning can also negatively impact your relationship with your spouse. Defaulting on your car loan or refinancing could leave your spouse feeling betrayed.
Alternatives to Cosigners
An alternative to getting a cosigner is to try to improve your credit score. And if your household has more than one automobile, or your current car is still drivable, you could use a refinance car loan calculator to determine whether refinancing could free up some cash that could be used to pay down debt or increase savings. A GAP waiver can also minimize liability for the difference between your car’s value and your current debt obligation.
Whatever you choose, it is worth it to explore all of your options, which could include delaying a purchase or refinance, improving your credit or working with specialists, who will work to help you get good terms on a loan that you can afford.
Chances are, if you’re a licensed driver, you probably have a car loan. Around 85% of all new car purchases and 53% of all used car purchases are financed in the U.S., according to a report by Experian. The average American household also has more vehicles than drivers, and many of those additional vehicles are financed too.
While you can have multiple car loans at the same time, lenders will want to know if you’ll be able to make payments on all of your financed vehicles. Qualifying for an auto loan may be a little harder this time around. Here’s why.
Yes, You Can Have More Than One Car Loan
The simple answer to this question is yes. If you have good credit and can afford another monthly payment, you should be able to finance another car.
Ultimately, a bank, credit union, or another financial institution is likely to provide auto loan financing to any individual they deem credit worthy, regardless of the types of loans they have on their credit history. In order to secure a second car loan and get the most competitive rates, you need to show the banks that you can afford the additional debt and will pay it back.
Lenders will look at the following factors when evaluating your car financing application:
Down payment:Do you have enough cash?
Credit score:Is it over or below 600?
Payment history: Have you been making all of your other payments on time?
Debt-to-income ratio: Is your DTI less than 50%?
If you have a relatively high monthly income, enough cash for a down payment, a good credit score, and a solid debt-to-income ratio, a lender may be more willing to give you an additional loan, and with a really great interest rate too.
If you have bad credit, it’s still possible to qualify for another car loan. There are many lenders who work specifically with borrowers with subprime, or poor, credit. Your interest rate may not be as competitive as someone with a higher credit score, but after a few months of on-time payments on your credit report, you may start to see your credit score go up.
A common strategy for borrowers with bad credit is to buy and finance the car, then wait a few months for the on-time payments to make a positive impact on their credit. Once their credit score goes up, they apply for auto loan refinancing to get a lower, more competitive interest rate.
Should You Take Out Another Car Loan?
There are many reasons why you might opt to use your credit to finance an additional vehicle, but you want to be sure you weigh all the pros and cons before taking advantage of all your financing options.
Perhaps you need another car for a spouse or child. Perhaps you currently drive a sedan and believe you could benefit from adding a truck or SUV to your fleet. All of these are totally valid reasons why you might seek an additional vehicle loan.
Pros of taking out another car loan:
Taking out an additional loan can help you achieve your goal without saving up a ton of money or waiting until your current loan term is up. But there are some downsides to consider as well.
Cons of taking out another car loan:
Having two or more loan payments can take a significant toll on your monthly budget, which may cause you to default on payments. What’s more, loan applications leave a hard inquiry on your credit report, which could cause your score to drop.
Do Multiple Hard Inquiries Ding Your Credit?
Depending on the circumstance, multiple hard inquiries may or may not hurt your credit.
Remember that each time you attempt to get approved for a new loan, you add a hard inquiry to your credit score. Hard inquiries can bring down your score five to 10 points, and too many can signal to a lender that you’re a high risk or irresponsible with credit.
However, multiple inquiries for the same type of loan during the rate shopping period will only count as one.
Consider Refinancing Your Loan(s)
If you have a high interest rate on your current auto loan, you may want to consider auto loan refinance. If approved, refinancing will help you get your annual percentage rate (APR) down, which will ultimately lower your monthly payment and free up cash for other monthly expenses, such as a second car loan.
Use our refinance car loan calculator to see how much refinancing could save you during the repayment process. If you have multiple car loans already, you may want to apply for refinancing to get lower auto loan rates and save money over the life of your vehicles.
Weigh Your Options
In theory, you can have as many car loans as a vehicle financing company will grant you, but you will need excellent credit and a high income to qualify for a second loan. There are no laws preventing an individual from taking out more than one car loan, so if it makes sense for your financial situation, it may be a smart option.
Weighing your options and evaluating your own unique financial situation is critical when deciding whether or not to take out an additional loan.
If you’re looking to improve your financial standing and lower your debt, you might want to consider paying off your car loan before the obligatory pay-off date. While doing so can certainly bring some benefits — more money in your pocket and the freedom of owning your car outright — there are a couple of important downsides to consider as well.
The Pros and Cons of Paying Off Your Car Loan Early
When you take out a car loan, you agree to pay for the cost of the vehicle (the principal) as well as interest. Your annual percentage rate (APR) is the percentage of interest you pay each month. When you pay more than the minimum, that extra money goes towards the principal, lowering how much you owe in interest. That’s just one of the pros of early pay-off, but there’s more to know.
Pro: Paying the loan off early could save you cash in the long run.
Making an extra payment here and there, rather than making a single lump-sum payment speeds up the repayment process without draining your savings. Just make sure your overage payments go toward the principal of your car loan rather than the interest. These are called “principal-only” payments.
Con: Some loans include precomputed interest, so early payoff may not save you money in the long-run.
It is important to note that some car loans include precomputed interest, or interest that is calculated upfront. In these cases, you may not be able to save money on interest if you pay off your loan early.
Make sure you determine the amount of interest pay-off will save you in the long run. To find out if your interest was calculated up-front, look at your statement. If your interest is precomputed, it will be lumped together with the principal rather than a separate fee. You should speak to your lender if you aren’t sure.
Pro: More money in your pocket each month.
Another advantage to paying off your car loan before the end of the term is that you will have less money tied up in bills each month. That means, in theory, you’ll have more money to spend in other areas of your life.
More money in your pocket each month may allow you to save up some extra cash faster for a new car, build an emergency fund, chip away at your student loans, or free up money for a down payment on a house. In many cases, it will help improve your financial situation. But remember that paying off your loan balance can be costly, so while it may lower your monthly budget, it may also put a significant dent in your savings account.
Pro: Improved debt-to-income ratio.
Simply put, your debt-to-income ratio, or DTI, is the percentage of credit you use each month divided by your gross monthly income. Your DTI is one of many factors lenders and other creditors use to determine whether you will be able to pay back a loan. If your debt-to-income ratio is too high, a lender might be hesitant to offer you credit since it could indicate that you’ve taken on more debt than you can pay back.
If you have a debt-to-income ratio above 50% and plan to apply for a new loan or line of credit soon, lowering your DTI can help improve your odds of getting approved.
So how do you lower it? By reducing your monthly debt obligations. Paying off a loan and eliminating a monthly payment, like a car loan, will improve your DTI. However, if paying off a loan in one lump sum is not possible, you can also try to refinance it to lower the monthly payment. In 2021, borrowers who refinanced their auto loans saved an average of $1,158 per year.
Con: You may have to pay a prepayment fee.
It’s critical you understand the terms of your loan since, although it’s rare, it may include a prepayment or pay-off penalty to your lender. Car loan companies impose these fees to make up for the potential interest lost over the life of your loan. These are more common if you have poor credit and a subprime auto loan (meaning you have a high interest rate on your loan due to bad credit).
Fees vary depending on the company and the terms of your loan, but you can expect to pay a maximum of 2 percent of your remaining balance in prepayment costs. Not all car loan terms include this penalty, so be sure to check yours before you decide what to do.
Con: less ‘positive’ activity on your credit score.
Consider All the Factors
Ultimately, deciding whether to pay off your car loan early is a big financial decision that comes down to a few key factors. The amount you owe, your interest rate, and the terms of your loan will have a major impact on whether or not prepayment is the best move for you.
If you’re considering buying a car, there’s a good chance you’ll wind up taking out an auto loan. The majority of drivers rely on car loans to cover all or a portion of their automotive purchase. In fact, Americans have about $1.18 trillion in car loans in total.
The interest rate on your car loan has a big impact on how much you pay over the life of your loan. It’s a percentage of your total balance charged by the lender or financial institution in exchange for the loan. The higher the rate, the more money you’re paying in interest each month until your loan is paid off.
That’s why it’s so important to make sure you get a good rate on your loan when buying a car. It raises or lowers the price you pay for the vehicle in total.
Whether you’re buying a new car or hoping to lower how much you’re paying for your current one, here’s how to determine whether you have a good interest rate on your loan.
Why Interest Rate Matters
The interest rate on your car loan is the fee you pay to the auto loan company for loaning you the cash up front. Lenders calculate monthly interest based on the principal or the total amount owed.
Note that interest rate and annual percentage rate (APR) are not the same. While interest rate is the annual cost of borrowing money and is calculated based on the principal, APR reflects the total cost of the car loan and includes the principal, interest, fees, and other things you rolled into the loan.
As you pay down the principal and your total amount owed lowers, so the amount you pay in interest lowers as well.
One of the simplest ways to determine how much you will pay in interest is to use an auto loan calculator online. Simply plugging in a few of the basics — the price of the car, your down payment, the length of the loan, the APR, and sales tax — will tell you the total amount of interest you will pay over time.
How Credit Affects Interest Rate
To get the lowest rates possible, you need to make sure you have great credit and are in good financial standing with your current lenders. Credit is rated by tiers, with tier 1 being the highest and tier 3 being the lowest. The higher the tier, the less information you may have to provide when applying for a loan.
Your credit score is determined by payment history, current account balances, length of your credit history, types of credit accounts, and other factors.
Every lender has their own underwriting guidelines, so it’s important to find a lender who will work with your credit profile and offer the most competitive loan terms.
It also helps if you use a cosigner who has good credit, choose a shorter loan period, or pay a bigger down payment to lower the overall loan amount.
You also want to check with multiple lenders, including online lenders, to “shop around” for the best rate. You may also consider heading into the car shopping process with pre-approval and multiple loan offers so you don’t risk winding up with a higher rate financing at the dealership.
What Criteria Financial Institutions Use to Determine Interest Rate
Financial institutions — such as banks and credit unions — determine loan rates based on a borrower’s credit. Lenders give borrowers with better credit ratings a lower interest rate because they are considered lower risk and they’re much more likely to pay back the loan in full. Every financial institution uses different criteria to determine whether someone is creditworthy.
Although every lender is different, they typically evaluate a borrower’s creditworthiness based on their credit report, which takes into account things like total debt in loans, credit cards, mortgages, and more as well as payment history, credit usage, and other factors. The average loan rates vary widely depending on where a borrower’s credit score falls.
Every financial institution evaluates credit differently and may provide you with a rate that’s higher or lower depending on many unique factors.
The Real Cost of Interest
Here is a simple example to help you see exactly how much interest rate affects your monthly payments and total interest paid.
Let’s say you want to buy a used car that costs $20,000 and you put $5,000 down as a down payment. That means your total loan amount is $15,000 plus the cost of taxes and fees, taking it to around $16,000.
If you have excellent credit and are able to secure a low interest rate of 3%, you will pay $354 a month and $999 in interest over the life of the loan.
If you have bad credit or no credit history, you’ll have a higher interest rate on your used car loan. In this example, let’s say your interest rate is 9%. In this case, you will pay $398 per month and over $3,000 in interest over the life of the loan.
As you can see, having good credit and securing a lower auto loan interest rate can save you thousands of dollars over the life of your loan. This means more money in your pocket for savings, monthly bills, and more.
How to Get a Good Interest Rate for a Car
So how do you get the best interest rate on your car purchase or refinance? Before you submit a single loan application, you want to make sure you follow the tips below.
Work on Your Credit
Boosting your credit score goes a really long way in securing the best auto loan rates.
So, how do you do that, exactly?
Pay Your Bills on Time
Always pay at least the minimum balance on time on your current loans each month. You may also consider paying debts down more aggressively to lower your overall credit use, which could boost your score.
Keep Accounts Open
As tempting as it may be to close old credit cards you’re not using, especially if they have high annual fees, don’t. Keep them open to help lengthen your average credit age.
Avoid taking out new loans
It’s also a good idea to avoid taking out any new personal loans or credit cards during this time since these can put hard inquiries on your credit and cause it to drop. If approved, it will also shorten your average credit age, which doesn’t look good to the bank.
Build Your Credit History
If you don’t have much credit history, consider putting utility bills in your name, signing up for a secured credit card, or asking a loved one you trust — and who trusts you! — to add you as an authorized user on one of their accounts.
Try Credit Raising Services
Many companies offer services to help you raise your credit score fast. For example, Experian offers an option that claims to raise your FICO score instantly.
Put More Money Down
Increasing your down payment is another great way to get a lower interest rate and smaller monthly loan payments. Not only will a higher down payment help convince the bank of your creditworthiness, but it will also lower the amount of interest you pay in total and each month since your interest payment is based on the principal loan amount.
Consider a Cosigner or Co-Borrower
To get a better rate, you may want to consider partnering with a cosigner or co-borrower. Though similar, a cosigner and co-borrower are not the same.
A cosigner is a person who signs the car loan alongside you, agreeing to pay the loan if you fail to do so. A co-borrower is similar, but will share ownership of the car as well as responsibility for the payments. Co-borrowers should both have access to the money used to buy the car.
Note that lenders may not allow a cosigner, only a co-borrower. This is because, in general, lenders don’t like when someone else’s credit is used to secure a loan for someone else. They expect the person on the loan to be the one who will own the collateral.
Often a parent, friend, aunt, or uncle, the cosigner signals to the automotive finance company that you are worthy of a lower interest rate. This is a huge thing to ask because you’re effectively asking someone else to put their credit on the line for you, so make sure to only use this option if you’re sure you can pay it back.
This is a great route to take for anyone without a strong credit history or those with poor credit who have improved their financial standing and are now able to pay loans on time each month.
Take a Shorter Loan Term
Auto loans are generally offered in different term lengths ranging from 24 months (two years) to 84 months (seven years). When you stretch your loan across a longer time period, it lowers your monthly payment, which means more cash in your pocket.
But there is a downside — If you take too long to pay off your loan, you may end up with a loan that exceeds the value of your car. That puts you and the lender at risk should your car be totaled and you owe more on the loan than the car is worth. If you have a guaranteed asset protection (GAP) waiver, you’ll be protected if your car is totaled and you still owe money on it.
Opting for a shorter loan period may be a great way to get the best interest rate based on your credit. When looking at your loan options, play with different terms to help determine how the rates vary depending on the loan term length you choose.
Sign and Refinance Later
If you aren’t able to secure the lowest interest rate possible that doesn’t mean you shouldn’t take out a car loan at all.
One great strategy is to take your less-than-ideal loan rate and refinance later. Having an auto loan can help you build good credit and ensure that you get a better rate later. After a few months of timely payments, you may see your credit score improve, and you may qualify for better rates than when you first bought your car.
You can refinance your new car loan in two or three months from the time you sign on, but it may be more beneficial to wait until you’ve boosted your credit history and score so you secure a lower rate.
Plus, if the interest rate savings are large enough, you may even end up paying less for the car by the time you’ve paid off the loan, just by getting a lower rate Use an auto refinance calculator to see how much you can save with a better interest rate.
Find a Rate You’re Comfortable with
If you’re a new borrower or are working on your credit score, taking a higher rate isn’t always a bad thing since it can help you boost your credit standing and helps get you on the road faster. Ultimately, there’s no magic number when it comes to the ideal APR. A good interest rate is one you’re comfortable with and one that fits into your budget.
