Interest on an auto loan is essentially the extra fee you pay for using the lender's money to buy a car. Luckily, the interest you'll accrue (and eventually owe) on your loan is spread out over the life of your loan, so you're not required to pay the fee back all at once.
QUICK TIP: You can lower the amount of interest you pay on your loan by paying more than the minimum required monthly loan payment each month. Or avoid interest altogether when repaying the lender in full (if possible). |
Some common questions we're asked at the credit union include:
These are all valid and excellent questions you should ask a lender before applying for an auto loan!
Unfortunately, you won't know your actual interest rate until you're either approved or pre-approved for the loan. In addition, if you're approved for the auto loan, but you're not quite ready to move forward, you could lose that interest rate and auto loan offer after a certain period of time (typically, pre-approvals are good for 30 days).
QUICK TIP: If you're unsure about an auto loan but want an idea of how much money you could be approved for, simply pre-qualify! I talk more about this in The Pros and Cons of Getting Pre-Qualified for an Auto Loan. |
In this article, I'll offer some peace of mind and share some factors lenders consider when determining your interest rate so you're better prepared.
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The interest rate you receive on an auto loan is based on a few factors, including:
QUICK TIP: Request your free credit report every 12-months, so you'll have a good idea of what your score is before walking into the dealership or financial institution. Get your credit report for free at annualcreditreport.com. |
Interest rates vary based on the lender, but you can generally expect a lower interest rate when borrowing from a credit union or a bank compared to the dealership. Credit unions specifically offer lower interest rates to their members simply because they're not focused on making profits (Psst... credit unions have better approval odds for a loan due to bad or no credit at all. Here’s why.).
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The comparison chart below is for demonstrative purposes only, but it can help you gain a better understanding of how interest rates are calculated. It includes a range of credit scores to help you better understand how lenders reach their calculations on interest rates.
Want to calculate your interest rate? Here's what you'll need:
Feel free to use the credit scores on the comparison chart above to help you get a sense of the interest rate you could receive when borrowing from a lender and calculating your estimated APR.
QUICK TIP: Change your cell format before you start calculating! When calculating the monthly payment using Google Sheets or Excel, make sure your cell number format is changed to Accounting. When calculating the interest rate using Google Sheets or Excel, make sure your cell number format is changed to Percent. |
Let’s say:
On your spreadsheet (i.e. Google Sheet or Excel), use the following formula to begin calculating your monthly payment:
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On your spreadsheet (i.e., Google Sheet or Excel), you’ll use the following formula to help you calculate your estimated interest rate:
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If you're not a fan of spreadsheets, there are plenty of interest rate calculators online you can check out instead. Calculator.net includes a detailed breakdown of terms as well as a chart and graph showing the principal and interest breakdown.
You can also use Skyla's loan payment calculator to find your monthly payments, total interest, and total loan cost. It helps to know your loan information, such as the loan amount, loan term (months), interest rate, and payment frequency.
Auto loans are typically offered at a fixed interest rate, meaning the interest rate doesn't change but the amount you pay for interest might. Interest on auto loans is calculated daily based on your total loan balance and depending on your payment habits, you could be paying more or less in interest each month on your auto loan.
Let’s break it down - Say you received a $10,000 auto loan with a 13.740% APR. You have 60 months (5 years) to repay that loan amount on top of the interest that's calculated daily. If you break that down month to month, your monthly payment would roughly be $231.
The $231 is made up of the interest amount and the principal amount (the amount that's going towards paying down that initial $10,000 loan). Here's an amortization chart so you can see the basic breakdown of the monthly payment for the first 6 months.
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If you were late making your monthly payment, expect that payment to go towards penalty fees first. Afterward, the rest of the payment would go towards the increased interest amount because you're more than 30 days late on your auto loan. Keep in mind, being late on your auto loan payment could open the door to paying more money like an increase to your overall borrowing cost.
The best way to avoid paying more interest or avoid interest accruing on your auto loan, make sure you:
Remember... interest will (most likely) be involved when financing a vehicle. Feel free to use the options above (interest rate formula, Skyla's calculators, or visit Calculator.net ) to calculate your interest. And don't forget to grab your free credit reports from annualcreditreport.com once every 12 months!
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Now that you understand what goes into calculating interest on an auto loan, you'll be more confident talking to your preferred lender when discussing rates.