How to calculate interest rate on car financing: If you are taking out a loan on your new vehicle, you will also be required to pay interest on that loan. Just how much you pay depends on a few factors. Below are the details on how to calculate interest on a car loan, so you can get a better idea of what your monthly payments may be on the vehicle of your choice.
What is an Interest Rate?
When looking at how to figure interest on a car loan, we first need to touch on what interest is and the factors that are looked at when calculating that amount. If you purchase a car on credit, your lender owns your vehicle until it is paid off. Because of this, you are required to pay interest, which is the fee the lender charges so that you can use their money to pay for your car. There are a couple of factors that go into determining this amount:
- Principal Amount: The principal amount is the cost you want to borrow.
- Loan Term: How long you plan on taking to pay off the loan also plays a role. Usually, with a short-term loan, your monthly payments will be higher, but you end up paying less in interest over time. Opt for a longer-term loan and your monthly payments will be lower, but over time, you will end up paying more in interest.
- Repayment Schedule: Usually, you will make a payment on your vehicle every month, but you are able to make payments more often if you prefer. Thanks to compounding, when you make more payments you pay less interest.
- Repayment Amount: Each time you make a car loan payment, a portion goes to interest, and the rest is put toward your principal.
Worried about your interest? There are ways to lower your future car loan interest rate.
How to Calculate Auto Loan Interest for First Payment
When figuring out how to calculate auto loan interest for the initial payment, the steps below can help:
- Divide your interest rate by the number of monthly payments you will be making over the course of the year.
- Multiply it by the balance of your loan, which for the first payment, will be your whole principal amount.
The number you get is the amount of interest you pay in month one.
How to Figure Interest on a Car Loan for the Future
After you begin to pay down your initial principal, you will then be required to determine your new balance to see what you will be paying going forward. Here is how you can calculate these payments:
- Subtract the interest you just calculated from the payment you just made and this will leave you with the amount that you have paid off the loan principal.
- Deduct this total from your original principal to get your new loan balance.
Errors in the calculation and the fact that the numbers are rounded will cause you do not have an exact calculation each time, but it does give you a good idea of how to calculate the interest rate on a car loan.