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.
