How to Calculate Your Car Loan Interest

If you're planning on buying a new set of shiny wheels, you may be wondering how to calculate car interest.

The interest rate on a car loan can significantly impact the total amount you end up paying for your vehicle, so it's important to understand how it works.

Car loan interest is generally no different to the interest you might pay on a home loan. Most car loans charge either a fixed (locked-in) or variable (can change) interest rate on the amount you’ve borrowed. This means in addition to repaying the initial principal, you’re also making interest repayments on top which:

A: is the monetary charge for the privilege of borrowing money from a lender, and

B: compensates the lender for the risk of lending you money.

Understanding Your Car Loan Interest Rate

Factors that affect your interest rate

The interest rate is typically expressed as an annual percentage rate (APR) and it can vary based on factors such as your:

• Credit score - Your credit score is a measure of your creditworthiness, and lenders will typically use it to determine your interest rate. The higher your score, the more likely you are to get a lower interest rate.
• Loan term - The shorter the loan term, the lower the interest rate and the less interest you will have to pay over the life of the loan.
• Secured versus unsecured - Secured car loans use an asset (usually the car) as security against the loan. This means that if you default on the loan, your lender may repossess your car as collateral. Whereas with an unsecured car loan, a lender does not have collateral to fall back on. This is why they tend to have a higher interest rate as the lender is under more risk should you miss repayments.
• Vehicle Age - The age of the car you're buying can also impact your interest rate. Newer cars may come with lower interest rates, while older cars may come with higher rates.
• Deposit - With some lenders, the bigger the deposit you put down, the lower the rate you may get because less is at risk for the lender. A smaller deposit may incur a higher interest rate due to the risk of default on a larger loan amount.

Calculating Car Loan Interest

To calculate car interest, you'll need to know your loan amount, interest rate, and the number of payments you will be making a year. The formula for calculating car interest is:

Total interest payment = Loan amount (outstanding balance) x (interest rate / number of payments per year)

Let's say you're taking out a car loan for $20,000 at an interest rate of 5% p.a. (with no balloon payment) and you’re making monthly repayments. In this case:

• The loan amount is $20,000
• The interest is 0.05 (5%)
• The number of payments is 12

So take the formula and plug in the numbers: 20,000 x (0.05/12)

Therefore, the interest payment in the first month is = $83.33

You will find that as you continue paying off your car loan every month, your interest payments will reduce each time. Below is an example.

Over a five year loan term, the $20,000 car loan with a 5% p.a. interest rate would have monthly repayments of around $375.

To work out how much interest you’ll pay in the second month, you need to calculate how much of the loan is left to repay (your outstanding balance), which you can do using the following formula:

Outstanding balance = principal – (repayment – interest cost of last monthly repayment)

So take the formula and plug in the numbers: $20,000 - ($375-$83.33)

= $19,708

In this case, after the first month, your remaining loan amount would be $19,708. Using that number we can now calculate what your interest payment will be in the second month.

Interest payment (second month) = $19,708 x (0.05/12)

= $82.11

Manually calculating your car loan repayments can be time-consuming, so head to loans.com.au’s Car Loan Repayment Calculator for a quick and easy way to find out what your repayments will be, and how much you’ll pay over the life of your loan.

A loan term will affect your monthly repayment and your total interest costs. A longer loan term means you'll pay less in principal each month because the total amount you borrowed is broken down over more months. This can be tempting as your repayments will be lower. However, a longer term also results in more interest charges over the life of that loan. Choosing a shorter loan term (that you can comfortably afford) may save you hundreds or even thousands of dollars in interest payments.

Calculating car interest may seem daunting, but it's an important step to take when considering a car loan.

If you’ve found your dream car and are in need of a low-interest rate car loan today, chat with one of our friendly lending specialists so you can drive away sooner.

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