How to calculate interest on a car loan

Auto loan interest is the cost of borrowing money to purchase a car. The lender will look at your credit score, debt-to-income ratio and other factors to determine what interest rate it offers.

To craft your budget, you should know your rate and how much goes toward your loan balance monthly.

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How does interest work on a car loan?

Most lenders use simple interest for auto loans. Interest is calculated based on the amount you owe — the principal — each month. As you pay down your loan, you will spend less on interest and put more toward the principal.

Precomputed interest is less common and may be used on auto loans for borrowers with bad credit. The lender will calculate the total interest paid over the loan term. That total is added to the principal and split among your monthly payments. Because interest is not amortized evenly, you will pay the same amount of interest no matter what.

If you don’t plan on paying off your loan early, there is no difference between simple and precomputed interest. If you do pay off your loan early, you will save more money with a simple interest auto loan.

How to calculate car loan interest payments

There are several ways to calculate your monthly auto loan interest payment. You can use an online loan payment calculator or work directly with a lender. As long as you know the principal, loan term and interest rate, you should be able to estimate your monthly payment — and the total interest you will pay.

Use an auto loan calculator.

Free, online auto loan calculators allow you to skip the pencil and paper and instantly determine your interest payment. These calculators allow you to find the monthly payment with different interest rates and loan terms.

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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 based on your down payment and how much you need to borrow.

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. You should prequalify with at least three before heading to a car dealership. Your auto loan rate is determined by factors including:

• Credit score. Lenders weigh your credit score heavily when setting your rates. The lower your score, the higher your rate. According to Experian data, the average rate for someone with excellent credit buying a new car was 5.61 percent in 2023. People with bad credit paid significantly more — with an average interest rate of 11.86 percent.

• Debt-to-income ratio. A lower DTI can mean a better rate because lenders will consider you less at risk of defaulting.

• 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 are less likely to become upside-down on your loan.

• Car age. Typically, the older the car, the higher the rate. If you want to buy a car over 10 years old, you may struggle to find auto financing at a reasonable interest rate.

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  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 help you 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: the annual percentage rate. The APR includes both interest and lender fees, expressed as a percentage.

Knowing what APR each lender will charge can help you find the car loan with the lowest overall cost. The interest rate listed on the main page is likely just the starting rate. You will likely need excellent credit of 740 or higher and a stable income to get that low rate.

Dealerships make it easy to buy and finance in one place. But often, a dealership will not provide the best interest rate. Instead, get preapproved with a few direct lenders first so you can negotiate like a cash buyer.

You should also look at the lender’s requirements and restrictions. You can check these on the lender’s website or by using its quote form or application. You may also want to look at reviews.

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. A larger down payment can be more cost-effective than a long loan term because you will have a smaller principal and pay less interest over time.

Experts often recommend you put at least 20 percent down, but that’s not a hard requirement in most cases. Because both new and used car prices have been increasing, the average down payment is over $6,000 in 2022, according to Edmunds.