How Car Loan Payments Are Calculated?

Introduction

How car loan payments are calculated can seem complicated, but it’s based on a simple formula used by lenders. By understanding the factors that go into the calculation, you can better estimate your monthly payment and shop for the best loan terms. In this comprehensive guide, Bigdatawiki will walk through how car loan payments are calculated step-by-step and provide tips for getting the best deal.

The Basic Car Loan Payment Formula

Lenders use the following formula to determine your monthly how car loan payments are calculated:

Monthly Payment = [Loan Amount x Interest Rate x (1 + Interest Rate)^Term] / [(1 + Interest Rate)^Term – 1]

Don’t let the math scare you. We’ll break down what each component means:

• Loan Amount: The total amount you’re borrowing to buy the car
• Interest Rate: The annual percentage rate (APR) on the loan
• Term: The length of the loan stated in months

This formula calculates the monthly payment needed to pay off the loan over the given term at the interest rate. The longer the term, the lower the payment since it’s spread out over more months. The higher the interest rate and loan amount, the larger your monthly payment.

There are several pieces of information needed to calculate how car loan payments are calculated. The main factors are:

• Purchase price of the car
• Down payment
• Loan term
• Interest rate
• Taxes and fees

Let’s look at how each one influences your monthly car payment.

Car Purchase Price

The purchase price of the car less any down payment determines the loan amount you need to borrow. The higher the loan amount, the higher your monthly payments.

For example, if you purchase a $30,000 car with a $5,000 down payment, your loan amount is $25,000. If you buy a $20,000 car with the same down payment, your loan is only $15,000 which results in lower monthly payments.

Down Payment

A higher down payment reduces the amount you have to borrow, which lowers your monthly payment. Save up as much as you can for a down payment to keep your monthly payments affordable.

Many lenders require a 10-20% down payment if you want the best rates. But some lenders offer loans with little or no down payment, which can be tempting but results in higher monthly payments.

Loan Term

The loan term is the length of time over which you’ll pay back the loan, typically 24 to 72 months. Longer terms of 5-6 years mean lower payments but more interest paid over the life of the loan.

A $20,000 car loan at 5% interest would have:

• $377 monthly payments over 60 months
• $310 monthly payments over 72 months

Interest Rate

The interest rate has a major impact on your monthly payment. Even a couple percentage points can make a big difference. The higher the rate, the more interest you pay on the loan which results in larger monthly payments.

Be sure to shop around among lenders and compare rates. Banks, credit unions, and online lenders all offer car loans with varying rates. Getting pre-approved can help you secure the best rate you qualify for.

Taxes and Fees

Don’t forget to factor in taxes and registration fees which are due when you purchase the car. These will add to the total you need to finance. Ask the dealer for a full breakdown of these costs to avoid surprises.

How Dealers Determine Monthly Payments

Now that you know what goes into the calculation, let’s look at how dealers determine your monthly payment when you apply for dealer financing.

The dealer starts by inputting the sale price of the car, your down payment and trade-in value if you have one. They’ll also verify your income, credit score and existing debts to determine the loan term and interest rate you qualify for.

The dealer may offer you multiple payment options based on different loan terms and rates. This allows you to choose the monthly payment that fits your budget. Be sure to look at the full deal including the interest rate, not just the monthly payment.

Dealers make money on dealer financing, so be wary of low monthly payments that extend the loan term. This adds more interest over the long run. Do the math yourself using online auto loan calculators.

Auto Loan Calculators

To forecast your payments, use online auto loan calculators like the ones below:

• Bankrate Auto Loan Calculator
• Cars.com Auto Loan Calculator
• Credit Karma Auto Loan Calculator

These tools make it easy to plug in different loan amounts, terms, interest rates and down payments to see how it impacts your monthly payment. Be sure to use the sales price without extras like extended warranties.

Tips for Lowering Your Monthly Car Loan Payment

Here are some tips to get the lowest monthly payment on your next auto loan:

Boost your down payment: 

Put down as much as you can upfront to lower the amount financed. This has the biggest impact on lowering your payment. Even an extra $1,000 can make a difference.

Extend the loan term: 

Stretching the term from 60 to 72 months will drop your monthly. But this adds more interest, so run the numbers to see if it’s worth it.

Improve your credit score: 

Aim for a credit score over 740 to qualify for the best rates and monthly payment options. Pay down debts and correct errors to increase your score.

Get pre-approved financing: 

Shop lenders before visiting dealers and secure pre-approved financing at the lowest rate you can find. This establishes a ceiling for dealer financing offers.

Negotiate the vehicle price: 

Don’t negotiate based on monthly payment alone. Haggle down the vehicle purchase price first, which lowers the amount you need to finance.

Compare multiple lenders: 

Get rate quotes from banks, credit unions and online lenders. Take the lowest rate to the dealer to see if they can beat it.

Opt for a lower-priced vehicle: 

Choosing a less expensive vehicle that better fits your budget makes the monthly payment more affordable.

The Bottom Line

Understanding how car loan payments are calculated allows you to make smart decisions about your new car purchase. Crunch the numbers yourself using online tools to forecast payments and determine the most favorable loan terms. 

With some preparation and negotiation, you can enter your auto loan with confidence and affordable monthly payments.