Key Takeaways
Your automobile is likely the second most costly investment you will ever make, after your home. And if you're like the vast majority of drivers, you'll switch cars several times throughout the course of your lifetime. The reality is that most of us need some sort of finance in order to buy a car. Both consumers and third-party lenders may benefit from such financing options. The interest rate on the loan will be the same regardless of the repayment plan you pick for.
But you should understand the nitty-gritty of the interest rates on these loans before you sign anything. A longer loan term with a lower interest rate may keep the monthly payment from being too high, but is it really the best option?
Auto loan interest can be either simply computed or precomputed by the lenders. Simple interest loans have interest accrued daily depending on the outstanding loan balance as of the payment due date. Your monthly interest payment will vary. The interest on a vehicle loan with precomputed interest is determined at the outset of the loan and is based on the principal borrowed. Your monthly interest payment won't change.
The interest you pay each month on a simple interest auto loan is calculated based on the outstanding principal on the payment due date. If you pay more than the minimum on your loan each month, you can reduce both your interest payments and your principal balance.
The interest on a loan with simple interest is capitalized and paid back in installments. Part of your monthly car payment with an amortized loan. And goes toward paying off the loan's principal, while the other part covers interest on the loan.
Car loan payments are front-loaded, meaning that more of each payment goes toward interest in the beginning of the loan and more goes toward principal at the end of the loan. An auto loan calculator can help you estimate your repayment plan.
Interest on some car loans is precomputed, meaning it is determined before you borrow any money. Payments are calculated by adding this sum to the loan's principal and then dividing the result by the loan's term in months.
Unlike with a simple interest loan, your payments won't be split between the principal and the interest. Paying more than the minimum due, making extra payments, or paying early to close the loan will not result in the same savings on interest as a simple interest loan would.
Cost of borrowing money can be expressed in two ways: Interest rate and APR (annual percentage rate).
Loan repayments are stated as a yearly percentage rate called the interest rate. Annual Percentage Rate (APR) equals interest rate plus all other fees associated with borrowing money. It is also a percentage, though. A higher annual percentage rate (APR) or interest rate indicates more money will be taken out of your account until the loan is paid in full.
All loan offers must include the annual percentage rate charged by the lender. Take into account the annual percentage rates (APRs), which provide a comprehensive picture of the financing costs, while evaluating various loan offers. When comparing rates, be sure you're comparing like with like in terms of APR rather than interest rate.
The average rate for a 48-month new-car loan in the first quarter of 2021 was 5.21%, while the average rate for a 60-month new-car loan was 4.96%, according to reports.
Your down payment, your credit score, and the length of your loan term are just a few of the variables that might determine the interest rate provided to you. Depending on your personal circumstances, your rate might vary in comparison to the national average.
Five-year loan with 4% interest rate
If you put down 10% up front and finance the rest of the $40,528 for five years at 4%, your monthly payment would be $746.38. Taking into account all of the interest, the total paid in monthly payments would be $44,783.09, which is $4,255.09. Including the initial down payment of $4,503, the car would cost $49,286.09 in total.
Eight-year loan with 4% Interest
If you put down 10% up front and finance the rest of the $40,528 for eight years at 4%, your monthly payment would be $494.01. The total amount paid would be $47,424.67 each month, which includes interest of $6,896.67. Adding the $4,503 down payment to the total cost of the car brings it to $51,927.67.
Five-year vs. Eight-year loan with 4% interest rate
With an eight-year term, your monthly payment is $252.37 less than with a five-year term ($746.38 vs. $494.01), but you pay $2,641.58 more in interest ($51,927.67 vs. $49,286.09).
Five-year loan with 6% interest rate
With a 10% down payment and a 6% interest rate over five years, the monthly payment on a $40,528 loan would be $783.52. Interest of $6,483.19 would be added to the monthly payments, which would bring the total paid to $47,011.19. Including the down payment of $4,503, the car would cost a total of $51,514.19.
Eight-year loan with 6% interest rate
With a 10% down payment and a 6% interest rate for eight years, the monthly payment on a $40,528 loan would be $532.60. The total amount paid over time would be $51,129.20, which includes $10,601.20 in interest. Including the initial down payment of $4,503, the car would cost $55,632.20 in total.
Five-year vs. Eight-year loan with 6% interest rate
With an eight-year term, your monthly payment is $250.92 less than with a five-year term ($783.52 vs. $532.60), but you pay $4,118.01 more in interest ($55,632.20 vs. $51,514.19).
Credit scores
In terms of interest rates, a higher credit score is preferred by lenders. Loans may be offered at higher interest rates to those with poorer credit ratings.
Type of lender
Credit unions are a great option for auto loans if you're able to pick your lender. Automobile loans from credit unions often have lower interest rates than those offered by banks. Also check out what the manufacturer's financing has to offer. It's possible that discounts might include interest rate reductions.
Loan term length
In general, interest rates for loans with longer repayment periods are higher. In addition, vehicle depreciation is rapid, so a longer loan period might leave you with a balance that exceeds the vehicle's current market value. Choosing a longer term can decrease your monthly payment, but it might also increase your interest costs throughout the life of the loan.
Down payment
The interest rate on your auto loan may vary based on the down payment you put down. The lower the rate you qualify for, the higher your down payment should be. Lenders may charge higher interest rates for loans with lower down payments because of the increased default risk.
New vs. Used
The interest rate on a car loan might vary on the basics of the vehicle, whether it is new or old. As a general rule, interest rates for used-vehicle loans are greater than those for new-vehicle financing.
Interest rate environment
Rates of interest fluctuate throughout time. They rise and fall according to fluctuations in the market. A rise in interest rates is a common response to a robust economy in an effort to contain price hikes.
The amount you ultimately have to pay back may increase by several thousands of dollars due to interest. Even if you have to take out a loan to pay for your automobile, you may still try to keep the costs down as much as possible.
0% APR financing
You may qualify for 0% APR financing for a set period of time if you have a high credit score and the manufacturer's financing program provides this option.
Early repayment
If your loan depends on simple interest, paying more than the minimum monthly payment or the principal balance in full will minimize the total interest paid.
Shorter loan term
Repaying your debt over a shorter period of time will save you money on interest payments. However, this will result in higher regular payments, so plan accordingly.
Refinance down the road
You may be able to acquire a better interest rate by refinancing your automobile loan later on if rates drop or your credit score rises.
The rate at which interest is accrued varies constantly. However, bad-credit borrowers have historically been subject to interest rates of 14.39% on auto loans.
Those in need of a vehicle loan would benefit greatly from a rate that is as low as possible. The average interest rate for a new auto loan for customers with credit scores of 700 and higher is 3.65%.
The total interest you pay on a car loan depends on a number of variables, not just the interest rate you choose. Regardless of the interest rate you're paying on your automobile loan, the length of your loan's term is a key factor in how much you'll ultimately spend for the vehicle. The cumulative interest charge will increase if the term duration increases while the interest rate remains the same.
Let us assume that you are paying interest at the rate of 10% on a loan for a car that costs $12,000. It's important to note that you may choose between the five-year loan (60 months) and the four-year loan (48 months).
Payments on the 48-month loan would be $304.35 per month, while payments on the 60-month loan would remain at $254.96 per month. The 60-month loan may seem more appealing when you consider the monthly savings. Keep in mind that you'll be charged interest at the rate of 10% per year on the outstanding balance of your auto loan.
There is a clear difference in the interest rates, with the 60-month loan costing more in the long run than the shorter 48-month option. In addition, because the 60-month loan reaches its steady state at a later date than the 48-month loan does, a larger percentage of each monthly payment will go toward paying interest for the longer loan term. For a loan term of 48 months, interest costs would amount to $2,608.85, while for a term of 60 months, it would cost $3,297.87.
It's worth noting at this juncture that if your interest rate is low enough, you may get a loan with a longer duration and still pay less for your automobile than you would with a shorter-term loan. If you're considering refinancing your auto loan, you should know the interplay between interest rates and loan term lengths.
This is because borrowers who refinance frequently prolong their loan terms while also securing lower rates. To add, understanding how the length of your auto loan term impacts your total interest paid is crucial if you want to save costs on your present loan.
Taxes are a complex topic that needs separate solutions, but the basic idea of how they affect your auto loan is simple. The tax you owe is placed on top of your loan amount when you buy a car since it is based on the vehicle's purchase price.
An 8% sales tax means that if you want to buy a $20,000 automobile, you'll need a $21,600 loan to cover your tax liability ($1,600 = $20,000 * 8%).
Please be aware that the interest rate you need to pay will remain the same regardless of your tax rate. You will be expected to pay interest on the whole sum borrowed, which will include the amount you need to borrow to cover tax obligations.
Even if your interest rate remains unchanged, the sum of your loan balance that will be used to calculate interest will increase if you owe taxes. Taxes are a necessary evil that no one can escape. You should still learn how your tax rate affects your vehicle loan.
Finding an online loan calculator and entering in your numbers is the simplest way to determine the interest you'll be paying each month on your vehicle loan. However, figuring it out on your own isn't that difficult.
Daily simple interest and a set monthly payment are possible loan terms for an automobile. This means that principal and interest might each get a proportionately larger or less share of your monthly payment.
There is a possibility that a bigger percentage of your initial monthly payment will go toward interest and that this percentage will decrease as your loan period progresses. Since your loan balance will drop as you make payments, you may use online loan calculators to calculate the percentage of your payment that went toward interest for the given month.
Simple interest loans have interest accrued daily depending on the outstanding loan balance as of the payment due date. Your monthly interest payment will vary. The interest on a vehicle loan with precomputed interest is determined at the outset of the loan and is based on the principal borrowed.
A car loan's interest typically follows an amortization schedule, similar to that of a mortgage, so you'll pay more in interest upfront but less over the life of the loan. The interest you pay will decrease and the principal you pay will increase as you make loan payments.
Car interests are actually calculated on a daily basis. A car loan's monthly payment, known as the Equated Monthly Installment (EMI), consists of principal and interest. When you finance a car purchase, you pay interest to the lender for the use of borrowed funds. Monthly interest is given more value.
The average interest rate for a 72-month vehicle loan is over 0.3% higher than the average interest rate for a 36-month loan for new automobiles.