How Does Car Loan Interest Work?

By

Automotive Content Editor

Meghan Carbary has been writing professionally for nearly 20 years. A published journalist in three states, Meghan honed her skills as a feature writer and sports editor. She has now expanded her skill-set into the automotive industry as a content writer for Auto Credit Express, where she contributes to several automotive and auto finance blogs.

, Automotive Content Editor - August 21, 2018

Nowadays, most car loans use simple interest. This means interest accrues daily based on the principal. It’s also virtually unheard of to have an auto loan with another interest type, like the dated rule of 78s car loan.

How to Calculate Interest on a Car Loan Manually

With simple interest car loans, as you make monthly payments, a portion goes toward interest, while the rest goes to reducing the loan principal. You can calculate how much of your monthly payment is going toward your interest and principal with some simple math.

For example:

• You’re financing an \$18,000 car for 60 months, with a 10 percent interest rate and a monthly payment of \$382.45 (for simplicity, we’re not accounting for sales tax).
• Multiply your principal loan balance by your interest rate to get a total (18,000 x 0.10 = 1800).
• Divide the total by days in a year to get your daily interest charges (1800 / 365 = 4.93).
• Multiply your daily interest charges by the number of days in a given month, either 30 or 31, to find out how much of your monthly payment is going toward your interest and principal (4.93 x 31 = 152.83).
• If your loan begins this month, \$152.83 goes toward your interest charges, while \$229.62 goes toward your principal balance (382.45 - 152.83 = 229.62).
• Repeat the next month using the new principal balance of \$17,770.38. Remember to account for the correct number of days in the following month (17,770.38 x 0.10 = 1777.04), (1,777.04 / 365 = 4.87), (4.87 x 30 = 146.10), (382.45 - 146.10 = 236.35).

As you can see, as you make payments, the amount of money going toward the interest decreases each month while the amount of money going toward the principal increases. This can be seen on an amortization table, and to get these figures yourself, you can use online tools and amortization tables to calculate these numbers.

Also, it can be helpful to use other online calculators, such as CarsDirect’s Car Loan Approval Amount Calculator and Auto Credit Express’ Monthly Payment Calculator, to get an estimate of what your monthly auto loan payment might look like.

How is Your Car Loan Interest Rate Determined?

A lot of factors come together to determine the interest rate you’ll pay for an auto loan. The biggest piece of the puzzle is your credit score, but factors such as the lender, the prime rate, the age and mileage of the vehicle, the down payment amount, and the loan term can all influence your interest rate.

One thing to keep in mind is that borrowers with lower credit scores typically only qualify for car loans with higher interest rates. Because this ultimately costs more in interest charges, compared to borrowers with lower rates, it’s a good idea to know how to save money over the term of your loan.

Saving on Interest Charges Over Time

There are no prepayment penalties when it comes to simple interest car loans. Because the amount of interest you pay is based on the amount you owe, making early loan payments can save you money, over time.

There are several ways to save money in interest charges:

• Pay more when you can – Pay any additional amount at any time to bring down the balance of your loan.
• Round up – Rounding up your payments gives you results that are a little more noticeable over time. Instead of paying the \$382.45 from the example above each month, try paying \$400. The extra \$18 can really add up.
• Bi-weekly payments – If rounding up makes your monthly payment seem too high, you could save yourself the financial pinch by making payments every two weeks instead of paying just once a month. This lets you make 13 full payments a year instead of 12.

The Bottom Line

If you need to finance a vehicle, let CarsDirect be your starting point. We have extensive new and used vehicle databases that allow you to shop for the right car for you right from your computer, tablet, or phone. Once you know what you’re looking for, we can help you find the right dealer to purchase from.

Our network of dealerships works with lending resources that can help people in many types of credit situations get the financing they need. The process is free of cost and obligation, and it’s simple to get started. Just fill out our easy online auto loan request form, and we’ll get to work finding a dealer for you!

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, Automotive Content Editor

Meghan Carbary has been writing professionally for nearly 20 years. A published journalist in three states, Meghan honed her skills as a feature writer and sports editor. She has now expanded her skill-set into the automotive industry as a content writer for Auto Credit Express, where she contributes to several automotive and auto finance blogs.

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