Unless you have excellent or near-perfect credit, you’re going to end up paying interest on your auto loan. What interest rate you can get, how much interest you pay in the long run, and what cars you qualify for all depend on some specific factors. Some of these you can control, while others you can’t.
Factors That Determine Your Interest Rate
It’s true that your credit score plays a role in determining your interest rate, but that’s not the only thing that determines it. There are four other factors that you need to be aware of when it comes to your interest rate:
- Your lender – Each lender has different programs and offers available.
- Federal rate – The Federal Reserve is responsible for setting the country’s base interest rate. This fluctuates, and it can be hard to pick the right time to finance for a lower interest rate.
- State you live in – Interest rates vary based on where you live due to differing state laws.
- Age and mileage of vehicle – New cars generally come with lower interest rates than used vehicles. The more miles a used car has, and the older it is, the higher the interest rate is likely to be.
The best way to pick and choose the best interest rate possible is by rate shopping. You should get quotes from at least two different lenders – but the more the better – and see what they have to offer you.
Understanding Interest Rates
Now that you know what determines an interest rate, how do you calculate the amount of interest you’re going to pay? Because auto loans are simple interest loans, interest is calculated on a daily basis based on the principal balance.
Let’s take a look at an example:
Martin takes out a $13,000 car loan with an interest rate of 17 percent for 60 months (five years). He wants to know how much interest he can expect to pay in the first month of the loan. Here’s how he does it:
- He takes his interest rate in decimal form, 0.17 percent, and multiplies it by the principal balance of the loan, $13,000, to get $2,210.
- Then, he takes that amount, $2,210, and divides it by 365 (the number of days in a year) to get his daily interest charge, which equals $6.05.
- Finally, he takes that daily interest charge and multiplies it by the number of days in that specific month. Let’s assume he takes out the loan in January, when there are 31 days. His monthly interest charge for January is $188.
As time goes on and you reduce the balance of the auto loan, less and less interest charges accrue with each payment made. It’s important you’re on top of each payment and pay it in full each month. Otherwise, your credit score suffers and the interest charges don't go down as quickly.
The Bottom Line
Paying interest on a car loan is almost unavoidable – especially if your credit is less than perfect. The good news is there are ways to get a lower interest rate down the road, like refinancing, once you improve your credit.
If you’re ready to get started on your car buying journey, but don’t know where to find a dealer that can work with you, we want to help. The Car Connection assists people with bad credit by matching them with special finance dealerships near them that work with subprime lenders. That’s not all we can do, though. With our new and used car sections, you can check out vehicles for sale near you and compare different models.
To get connected to a local dealer, simply fill out our easy and free auto loan request form, and we’ll get right to work for you.