How Are Auto Loans Calculated? (And Why You Should Care)
When shopping for an auto loan, you know that you want the best rate and the lowest payment you can get. But do you ever stop to think about how auto loans are calculated? If not, it's time to have that conversation! There are calculations behind the amount and various factors that help determine what it should be.
Before looking further at how auto loans are calculated, it's important to understand the factors that go into this calculation:
- Vehicle price
- Sales tax
- Trade-in value (if applicable)
- Down payment (if applicable)
- Dealer fees
- Rebates or incentives (if applicable)
- Annual percentage rate (APR)
- Auto loan term
How Are Auto Loans Calculated?
Calculating the cost of an auto loan involves following a mathematical formula. It might not be as simple as 1+2=3, but the concept is the same!
If you take the factors listed in the previous section and plug them into the right spot in the equation, you will get your monthly auto loan rate. There are auto loan calculators that can give you an idea of this amount, but understanding the how behind the calculations is essential as well.
First, it's important to note that an auto loan is an amortizing loan. This means that you pay back the amount of your loan plus interest. Your payments are the same each month and include the principal balance plus interest. Each payment you make will be the same; however, as you make more payments, you will pay more towards the principal and less toward interest.
Again, you can choose to use a calculator or rely on your lender to calculate your auto loan payment, but it's good to understanding the mechanics behind how and why auto loans are calculated the way they are.
Importance Of Knowing How Auto Loans Are Calculated
Now you may still be wondering why this even matters. Here's the deal.
You should understand how various factors impact your auto loan so you can make the best choices regarding your down payment, car prices, add-ons to your purchase, etc.
Auto Loan Term
For example, you might think that stretching your term out to 96 months is a good idea without knowing that the longer your term, the higher your interest rate and the more you'll pay over the length of your loan. Without this information, you could make the blind decision that you need to make your loan payment as small as possible without looking at the whole picture!
| Loan #1 | 60 Months |
|---|---|
| Loan Amount | $25,000 |
| Interest Rate | 3.11% |
| Monthly Payment | $555 |
| Total Cost of Car Loan | $26,620 |
| Loan #2 | 72 Months |
|---|---|
| Loan Amount | $25,000 |
| Interest Rate | 3.11% |
| Monthly Payment | $381 |
| Total Cost of Car Loan | $27,437 |
Auto Loan APR
Another example is not understanding how much your APR can impact your monthly payment. That's why you must get your APR down as low as possible before you get an auto loan. It can save you thousands of dollars throughout your loan term!
| Loan #1 | 3.11% APR |
|---|---|
| Loan Amount | $25,000 |
| Loan Term | 60 Months |
| Monthly Payment | $450 |
| Total Cost of Car Loan | $27,026 |
| Loan #2 | 10.11% APR |
|---|---|
| Loan Amount | $25,000 |
| Loan Term | 60 Months |
| Monthly Payment | $533 |
| Total Cost of Car Loan | $31,952 |
Auto Loan Principal
One final example relates to what makes up your principal loan amount. You might only consider the sticker price of the car, but the principal loan amount is the sticker price + fees + taxes + maintenance or insurance add-ons, which can easily increase your principal loan amount by a few thousand dollars.
The comparison below demonstrates how much an additional $5,000 can impact your monthly payment and total cost of the car loan.
| Loan #1 | $20,000 |
|---|---|
| Loan Term | 60 Months |
| Interest Rate | 3.11% |
| Monthly Payment | $360 |
| Total Cost of Car Loan | $21,621 |
| Loan #2 | $25,000 |
|---|---|
| Loan Term | 60 Months |
| Interest Rate | 3.11% |
| Monthly Payment | $450 |
| Total Cost of Car Loan | $27,026 |
Understanding Auto Loan Calculations
Now that you’re aware of why you should care about how auto loans are calculated don't stop there! Before you get your next auto loan or refinance your current vehicle, you want to be fully knowledgeable about the ins and outs of auto loan financing so you can get the best deal and make the right choices.
Here are additional resources you can refer to that provide helpful information about auto loans:
