Why Am I Charged Interest on Car Loans?

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Contributing Writer

Bethany Hickey is a graduate from the University of Michigan-Flint, with a bachelor’s in English-Writing. She is a content writer for Auto Credit Express, CarsDirect, and many other automotive blogs, as well as the Poetry Editor for UM-Flint’s writing magazine.


, Contributing Writer - May 6, 2020

Car loans are almost always simple interest loans, but why is there interest on loans in the first place? We cover why you’re charged interest on car loans, what determines your interest rate, and how you can lower your interest charges.

What Is Interest?

Simply put, interest is the cost of borrowing money. Your lender loans you money so you can pay for large purchases, and you pay the lender interest for the right to borrow that money.

Nearly every auto loan is a simple interest loan, meaning it’s a type of loan which accrues daily interest. With simple interest, you’re charged interest only on what you owe – not the original amount you borrowed. With each on-time payment, you’re decreasing the amount you’re charged in interest each month until the loan is completed.

A car loan is typically one of the biggest purchases anyone makes. It’s a long-term commitment, and the longer you stretch that commitment, the more you pay in interest charges.

Determining Your Interest Rate on a Car Loan

On car loans, your interest rate is largely determined by your credit score and the type of vehicle you’re financing.

Your credit score is generated from your credit reports, which have data on how well you’ve handled repaying money in the past. If you’ve had a good history of making on-time payments, successfully completing loans, and having different types of credit, your credit score is likely to be higher.

On the flip side, if you’ve missed some payments, have late payments on your credit reports, or haven’t taken out any credit, your credit score is likely to be lower. As a bad credit borrower, this means auto lenders may turn you down for a car loan or charge you a higher interest rate.

The vehicle you’re financing also has an impact on what your interest rate will be. Generally, new cars have lower interest rates than used ones. This is because newer vehicles generally have less of a chance of breaking down, are more reliable, and it’s easier to determine their value.

Used cars have higher mileage, wear and tear, and, after a few years, it can be hard to judge a used vehicle’s actual cash value. Because of this, lenders typically charge higher interest rates for a used car loan.

The plus side to taking out an auto loan on a used vehicle is that you typically finance less, meaning you still may pay less in interest charges over time compared to a new car.

Decrease Your Interest Charges

There are quite a few ways to decrease how much you pay in interest charges. One way is to try to get the shortest loan term you can. A longer loan term can lower your monthly payment, since the total amount you owe is stretched over a longer period. Simple interest is calculated every day, meaning a longer loan term equals additional interest charges, while a shorter loan term means more savings over time.

Another way to decrease the interest charges is by making a down payment or using a trade-in with equity to put toward the loan. This lowers the total amount you finance, and if you’re a bad credit borrower, it increases your chances of an auto loan approval.

If you choose to finance for the longest loan term possible to keep your payment low, you can lower how much you pay in interest charges with a down payment.

For example, if you finance $15,000 with a five-year loan (60 months) with a 12% interest rate, you pay:

  • $334 a month
  • $5,020 in interest charges
  • $20,020 overall for the loan

Now, say you put $2,000 down in cash/trade-in equity toward the same loan. You now pay:

  • $289 a month
  • $4,351 in interest charges
  • $19,351 overall for the loan

With a down payment, you save almost $700 dollars in interest charges since you’re only financing $13,000. On top of that, you have more disposable income every month because you’re lowering your monthly payment.

Interest charges can add up quickly, but being strategic in how you finance your next car can save you some of your hard-earned cash.

Buying Your Next Car

Even if you’re a bad credit borrower, there are often still ways to get financed for your next car loan. Since your credit score is a large part of your interest rate and whether or not you can get approved, finding the right dealership and lender is key.

If you’re struggling with credit issues and having trouble getting approved by a traditional auto lender, a subprime car loan could be for you. When you work with a subprime lender, you’re more than just your credit score – they look at additional factors during the loan approval process.

At CarsDirect, we know which dealers have special finance departments that work with subprime lenders. To get matched with a dealership, simply fill out our free auto loan request form. It’s secure, quick, and we’ll match you to a dealer in your local area.

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, Contributing Writer

Bethany Hickey is a graduate from the University of Michigan-Flint, with a bachelor’s in English-Writing. She is a content writer for Auto Credit Express, CarsDirect, and many other automotive blogs, as well as the Poetry Editor for UM-Flint’s writing magazine.


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