Auto loan interest is the cost of borrowing money to purchase a car. Auto loan interest rates are expressed as a percentage. When expressed as an APR (annual percentage rate) it includes any lender fees, including loan origination fees, loan setup fees and commission.
Interest is calculated with a few factors in mind. The bank will look at your credit score and debt-to-income ratio — along with other factors — to determine what interest rate it offers you. In essence, the less creditworthy you are, the higher your interest rate will be.
How to calculate car loan interest payments
There are several ways to calculate your monthly auto loan interest payment. You can calculate it on your own or use an online loan payment calculator, or work directly with a loan officer.
Calculate car loan interest payment on your own
To start, find the amount, interest rate and the term of your auto loan. The term may be anywhere from 24 months to 84 months — but the longer you take, the more interest you’ll pay. The lender will also factor in your down payment and how much you’re borrowing.
Using this information, you can then calculate how much your monthly interest payment will be. Since an auto loan is amortized — like student loans and mortgages — it’s a bit more complex than a simple interest calculation. You’ll need to first divide your interest rate by the number of payments you’re making in a year, likely 12. Then you’ll take that number and multiply it with the balance of the loan.
To get the monthly interest payment on a $25,000 loan with a 4 percent interest rate with monthly payments, you would take 4 percent expressed as a decimal (0.04) and divide it by 12, then multiply the result by 25,000. This comes out to an $83 interest payment for your first month. To get the next month’s interest payment, you would repeat the process with the new loan balance.
Use an auto loan calculator
You can take this a step further using an auto loan calculator. These calculators allow you to find the monthly payment with different interest rates and loan terms. The Bankrate auto loan calculator will also provide a full amortization schedule so you can see the amount of interest you’re paying each month and the total interest paid over the life of the loan.
Talk directly to a lender
You can also talk to a lender directly to compare potential rates. Working with a loan officer means you can get a customized idea of what your loan might look like, including potential interest rates.
Factors that determine car loan interest rates
To get an idea of what interest rates are available to you, you can prequalify with several lenders. It’s recommended that you prequalify with at least three before heading to a car dealership. Your auto loan rate is determined by a number of factors, including:
- Credit score. Banks and lenders have systems in place to determine your creditworthiness and to set your rates. The lower your score, the higher your rate.
- Loan term. Generally, longer loan terms result in higher rates. It also means a higher amount paid over the life of the loan but can carry lower monthly payments.
- Down payment. Making a large down payment means you are borrowing less, and that you are less likely to become upside down on your loan.
- Car age. Typically, the older the car, the higher the rate.
- Work and education experience. Some lenders now look at your job history and education when determining your interest rate, which means you could qualify for a decent rate without the best credit score.
How to avoid paying too much interest
With the right strategy, you can pay less interest. Here are a few tips to keep in mind to save money:
Shop around for the best deal
As with other types of loans, the overall cost of a car loan comes down to one major factor: APR. Knowing what APR each lender will charge can help you find the car loan with the lowest overall cost.
Don’t just focus on the number, though. Look at the lender’s requirements and restrictions too. You can check this on the lender’s website or using its quote form or application. You may also want to look at reviews.
Remember that the interest rate listed on the main page is likely the starting rate. To get that low rate, you will likely need excellent credit of 740 or higher and a stable income.
Save up before you buy
If you have some cash of your own, you can use that as a down payment on your vehicle, which will lower your monthly payment and interest costs. While it may seem counterintuitive, a larger down payment can be more cost efficient than a lengthy loan term, since you’ll pay less principal and thus less interest over time.
It’s typically recommended that you put at least 20 percent down, but that’s not a hard requirement in most cases.
Don’t just check with the dealer
Dealerships make it easy to buy and finance in one place. But oftentimes a dealership will not provide the best interest rate.
Get preapproved with direct lenders before going into a dealership to be sure you’re getting the best rate available. Plus, going in with a preapproval offer lets you negotiate like a cash buyer.
The bottom line
Car loan interest rates are based on several factors including your credit score, the length of the loan, your down payment, the age of the vehicle and the interest rate. Look at what you’ll be paying in interest for different amounts, terms and rates before settling on a loan. Doing so will help you to make an informed decision and avoid paying more interest than you should.