Breaking Down the Formula for An Auto Loan

Financing a new or used vehicle can feel complicated when trying to figure out all the moving parts. But by breaking everything down into their individual pieces, you can begin to understand how to maximize the different factors that make up an auto loan payment so you can get the best deal.

The Basics of an Auto Loan

Auto loans can be broken down into three basic parts:

• Principal: The amount you borrow is determined by the cost of the vehicle.
• Interest: The annual percentage rate (APR) determines what you pay in addition to what you borrowed.
• Term: The length of time to pay back the loan. Auto loans generally last between three and seven years.

Taking those three pieces, you can calculate the total interest of the loan:

• principal amount x interest rate x term (in years) = total interest.

Example: $10,000 x 0.0599 x 10 years = $5,990 in interest paid. This assumes that payments are being made on time and don’t include additional fees. For a more detailed look at an auto loan payment, use our auto loan calculator.

Principal

The principal is the total amount borrowed from the lender. As it applies to an auto loan, it’s the cost of the vehicle minus the down payment. The more of a down payment you make, the less you’ll have to borrow, which can lower how much you pay in interest.

When making a down payment, try to put down at least 20% for a new vehicle purchase, and at least 10% for a used one.

Interest Rates

Interest rates can be either fixed or variable. Fixed rates will stay the same for the length of the loan term while variable rates will adjust according to the markets at certain intervals. Auto loans are commonly fixed-rate loans and can be refinanced later if rates get lower.

Here are the factors that affect the rate you can get from a lender:

• Your credit score: The higher your credit score, the better your chances of a lower interest rate.
• The loan term: The shorter the term, the lower the rate and the lower amount of interest needing to be paid.
• The loan amount: Many lenders have minimums on the amount borrowed depending on the length of the loan term.
• Age of the vehicle: The older the model, generally the higher the interest rate.
• The lender: Financial institutions will offer their rates. Credit unions typically have lower rates compared to for-profit lenders.

Dealerships will have their own financing departments to offer convenient auto loans on-site, but their rates tend to be higher than what you can get from banks, credit unions, or online lenders.

For borrowers with a lower credit score or no credit history, a co-signer can improve their chances at approval and a lower interest rate. This is helpful for first-time car-buyers.

Loan Term

The term of the loan is the amount of time you must repay the loan. If you pay off the loan sooner than the agreed-upon date, some financial institutions carry a prepayment penalty.

The length of the loan determines how long you’ll be paying interest and how much money you’ll be paying back monthly. If you can afford higher monthly payments, having a shorter loan term means paying less in interest and saves you money overall. A longer loan term can help free up money with a lower monthly payment, but you’ll be paying more in interest.

Other Factors to Consider for an Auto Loan

In addition to the amount borrowed and the interest payments, there are other fees that’ll add cost to the bottom line. These can include origination fees and prepayment penalties.

Refinancing an auto loan to a lower interest rate can add to the loan term and incur new fees since it’s a brand-new loan. The new fees can be potentially offset by the lower interest rates.

Additional Auto Loan Help

Hopefully, you have a better understanding of how auto loans are structured and how much you’ll be paying back. You can also use an auto loan calculator to run through different payment scenarios to get an idea of what works best for you. For additional assistance, call our auto loans express team.