When financing a brand new or used car purchase, you pay back in monthly installments over the loan term, which is usually a few years. However, you may not be aware of the amount of principal remaining after each payment, or what the breakdown of your monthly installments are.
Knowing how your monthly payments are calculated, and what are included, will help you budget your finances well, and you will likewise know the real cost of the purchase, and not only the car’s price tag. It can overwhelm the uninitiated, but being well-informed and having an online loan calculator available will make the process of computing the interest and other loan fees easier.
Read on as we discuss how interest rates work on car loans, as well as how to calculate car loan interest. You’ll also learn what are normal and ideal loan interests, and how to avail of lower interest rates.
What Is The Interest Rate on a Car Loan?
The interest rate on a car loan is the annual cost of borrowing money in a percentage format. The interest rate doesn’t include any loan charges. The Annual Percentage Rate (APR) is the cost of borrowing money in percentage that you pay each year, including loan fees.
What Is a Good Interest Rate for a Car Loan?
The average interest rate for new car loans is 5.16%. For used cars, it’s 9.34%. A good credit score to target is anything under 4% for a new car. Having a credit score over 780 will put you in a great position to get such an offer.
Does Car Loan Interest Accrue Daily?
Car loan interest is usually calculated daily based on the principal. To calculate the daily interest, just divide the annual interest rate by 365, and by 366 if it’s a leap year. For instance, if your $10,000 loan balance bears interest at 3%, the daily interest is around $0.82.
What Is a Good Interest Rate for a 72 Month Car Loan?
Most lenders simply calculate the monthly interest by multiplying the principal by the interest rate. The more monthly payments you make, the more is applied to the principal, bringing down the interest in your future payments. Interest is evenly amortized over the loan term.
Each monthly payment includes interest, the total of which can amount to thousands of dollars added to the principal. This is why you need to understand how interest is calculated, and what factors affect interest rates. This way, you’ll also learn how to lower interest charges.
How Does Interest Rate Work on a Car Loan?
Most lenders simply calculate the monthly interest by multiplying the principal by the interest rate. The more monthly payments you make, the more is applied to the principal, bringing down the interest in your future payments. Interest is evenly amortized over the loan term.
Each monthly payment includes interest, the total of which can amount to thousands of dollars added to the principal. This is why you need to understand how interest is computed, and what factors affect interest rates. This way, you’ll also learn how to lower interest charges.
What You Need to Know When Calculating Car Loan Interests
All car loans bear interest that you shoulder throughout the loan term. However, it may differ, depending on the lender and your credit standing. Thus, having a good grasp of how interest rates work is crucial. There are several factors that affect a car loan, and understanding them will be helpful.
- Principal – The total amount borrowed for the car loan.
- Loan Term – The length of time given to fully settle the loan. Usually, the shorter the loan term, the higher the monthly installments, and the smaller the total interest. Conversely, a longer term usually requires lower installments but higher overall interest.
- Repayment Schedule – Car loans typically require monthly payments. You can make more frequent payments than required to save money on interest.
- Repayment Amount – Part of your monthly payments is for interest, and a part is applied to the loan principal.
How to Calculate Interest Rate on a Car Loan
Knowing how to calculate the car loan interest will help you budget and properly allocate your funds. Here’s how to do it.
1. Calculating Interest on a Car Loan for First Payment
This is the interest rate computation for the first payment:
- Get the interest rate and divide it by the number of monthly installments in a year.
- Multiply your monthly installment by the principal amount.
- The product is the interest rate for your first installment.
2. Calculating Auto Loan Interest for the Coming Months
A different formula is necessary to calculate your succeeding installments.
- Deduct the interest on your remaining balance. The difference will be the balance of your principal.
- To get your new loan balance, subtract the amount you get above from the original principal amount.
The computations above are just estimates of your loan payments that you can use as a guide. It may vary from the actual amount you need to pay.
Key Takeaway:
Different calculations are used to calculate your estimated initial loan payments and future installments. Use the estimates as a guide to help you allocate funds for your loan.
How to Calculate Interest on a Car Loan Manually
While loan payment calculators are available to do the calculating for you, it is also helpful to know how the calculators come up with the figures. The CFPB has provided a loan payment calculation worksheet that you can fill up.
The worksheet can help you figure out the amount of interest to pay. You then add the interest to the principal. Just divide the result by the required number of monthly payments required for the loan term to get the monthly installment.
To calculate the interest cost, use the formula I = P x R x T.
- "I" is the cost of interest.
- "P" is the original borrowed amount or principal.
- "R" is the interest rate, in decimal form.
- "T" is the term of the loan.
Key Takeaway:
To ensure accuracy, make sure that the term and rate use the same time intervals. When using annualized interest rates, you need to calculate the term in years.
Are Car Payment Calculators Accurate?
While loan payment calculators are useful, they’re not perfect. The figures they provide vary, depending on the calculator you’re using. Some will offer an estimate of your monthly payment, while some will even work backward to calculate the maximum amount you can afford to pay each month.
How Much Interest Is Too Much For a Car Loan?
Ideally, a car loan interest should not go beyond 25%. However, since loan rates vary, what may be too much for one individual may actually be quite reasonable for another. APRs on car loans range between 0% and 25% as determined by your credit rating.
How Can You Lower Your Car Loan Interest Rate?
There are ways to lower your car loan interest payments. Just make sure to study all options before agreeing to make sure you get the best possible deal.
1. Lower Your Car Payment With Refinancing
Having your loan refinanced can lower your interest rate by an average of 2.4%. While this may seem small at first glance, it can add up to a significant amount throughout the duration of the loan.
2. Lower Your Car Payment Without Refinancing
- Request for a loan modification – Since lenders find repossessions tedious and costly, they may be amenable to modifying your loan. This may include adjusting the term or lowering the interest to make monthly payments lighter.
- Shop around for offers – You may pay lower car loan interest by putting up a big down payment, choosing a shorter term, making extra payments, and removing options for extra coverage.
Final Verdict
While online loan calculators may be readily available, it is still a good idea to learn how to estimate the monthly loan payments on your own. This way, you will have a good idea of what to expect monthly, allowing you to budget your funds accordingly.
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