Your interest rate on an auto loan plays a big role in determining how much you end up paying for a vehicle. Therefore, understanding how yours is determined and how auto loan interest rates work in general is important.
How Your Interest Rate is Determined
Auto lenders use several factors when setting your interest rate, but your credit score is far and away the most important. Borrowers with excellent credit scores will qualify for the lowest interest rates. Conversely, the lower your credit score, the higher the interest rate you will qualify for.
Of course, there are other factors that play a role in determining your interest rate. These include:
- The Age and Mileage of the Car. Interest rates available for new and used vehicles differ. Generally speaking, lenders offer lower rates for new cars. Additionally, rates can vary for used cars based on their age and mileage. Cars that are older and/or have higher miles will come with higher APRs.
- What State You Live In. Because of differing state laws, interest rates can vary based on where you live.
- The Lender. Different lenders have their own programs, meaning they offer different rates.
- The Federal Rate. The Federal Reserve sets the country's main interest rate, which generally affects the rates lenders offer at a particular time.
All of these variables make it tough to figure out your interest rate until you have been approved for a car loan. This is also the reason why consumers with good credit "rate shop" when they need a car loan. This involves applying with multiple lenders to find the one that can offer you the lowest interest rate.
How Auto Loan Interest Rates Work
Car loans use a simple interest formula. With simple interest auto loans, interest is computed on a daily basis based on the amount of the outstanding balance.
Here's how that works. Let's say you take out a $16,000 loan and your APR is 9%. You can figure out how much interest you'll pay in the first month of that loan with a few simple calculations.
- First, take your interest rate in decimal form, 0.09 in this case, and multiply it by the principal balance of $16,000. 16,000 multiplied by 0.09 = 1,440.
- Next, take that figure and divide it by 365, the number of days in a year, to get the daily interest charge. 1,440 divided by 365 = $3.94.
- Finally, take that daily interest charge and multiply it by the number of days in that particular month. May has 31 days, so, assuming that's when you'll make a payment, that's what we'll use in this example. $3.94 multiplied by 31 = $122.14.
When you make a payment on a simple interest loan, it is applied to the interest charges first and the principal balance second. Let's continue with the example above where the amount of interest that accumulated that month was $122.14. If your monthly payment was $300, $122.14 of that would take care of the interest charges, while the remaining $177.86 would be applied to the principal.
For the next month, you can do the same calculations, after adjusting the principal balance and the days in the month. As you can see, as long as you pay on time every month, less and less interest will accrue with each payment that you make, meaning more of your monthly payments can be applied to the principal. This pattern of decreasing interest payment and increasing principal payments continues until the loan is paid off.
Simple interest auto loans present savvy consumers with an opportunity to save money in the long run. Check out some of the money-saving strategies you may be able to utilize.
The Bottom Line
A car loan is a big purchase, so it's important to understand every little detail. Hopefully, you now have a better feel for how auto loan interest rates are set and calculated.
If you need to finance a car, but your credit is making getting approved difficult, it's time to try Auto Credit Express. We make finding financing faster and easier for borrowers with less than perfect credit.
Get the process started by filling out our fast, free and secure car loan request form today.
