We all know that car loans are made up of the amount you borrow, the principal and interest, but is that it? Is there more to how car loans are calculated? We asked our auto loans team to explain how to calculate car loans and why you end up paying what you do.
How to Calculate Car Loans
There are three main influences over the cost of a car loan, the amount you borrow, the interest rate you’re charged and the term of the loan. Each combine to make up the overall cost of the loan, less any fees.
The Loan Principal
The loan principal is the amount you’re borrowing. This is usually the headline figure and will be close to the value of the car you’re buying with it, less the down payment.
The more you borrow, the lower the interest. Borrow less and you’ll likely pay higher interest.
Borrow over a longer term and you’ll pay a lower rate but more interest over the term. Borrow over a shorter term and you’ll pay more each month but less interest over the term.
Car Loan Interest
Lenders are in the business of making money and loan interest makes up some of that. Interest also serves to mitigate the risk the lender is taking in handing you lots of money.
The higher your credit score, the better with debt you are, so the lower the risk you are perceived to be.
Lower credit scores are seen as not being so good with debt and a higher risk, so the interest rate is higher.
Car loan interest is also front loaded. This means a higher percentage of your first year or two of loan payments will be interest. This evens out over time so towards the end of the loan term, you’ll be paying more loan principal than interest.
This is also to preserve the lender’s profit.
The Car Loan Term
The car loan term is the number of months you take out the loan for. Car loans are fixed term arrangements, meaning you sign up to pay the loan over a set number of months at a set interest rate.
While you can overpay or settle early, the overall loan is set.
The longer the car loan term, the more individual interest payments you make. Even though the rate may be lower, you’ll make more of them.
The shorter the loan term, the fewer interest payments you’ll make, so the cheaper the loan. The rate may be slightly higher though.
Aside from fees or charges, that’s how a car loan is worked out. It’s both simple and complex and can be easy to understand, or not, depending on how good with numbers you are.
Whatever your situation, if you want expert advice on car loans, contact one of our team.
If you’re ready for a car loan, we’d love to help! simply click here to get pre-approved online today.