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How Is Interest Calculated on a Car Loan?

If you are applying for your first car loan, you may have some important questions about interest. What are interest rates? What is an APR? How is interest calculated on a car loan?

Keep reading to learn more about interest rates and what you can expect when financing a vehicle.

Interest Rates Explained

When it comes to borrowing money, an interest rate is the cost of doing business. Interest is paid to the lender as a result of receiving funds and is a percentage of the principal owed. For example, if you borrow $10,000 at 10% interest, you will pay $1,000 in interest.

Your interest rate can make a huge difference in the total amount that you pay over the lifetime of the loan. The lower the interest rate, the less additional cash you need to give the lender, and the lower your monthly payment will be. So to help keep your monthly payments low, it pays to score the best possible interest rate on your loan.

One of the things that confuse many consumers is the difference between the annual percentage rate (APR) and the interest rate. The APR is essentially your interest rate plus any additional annual costs for the loan, such as annual service fees. If there are no fees, the APR may be the same and indistinguishable from your interest rate.

Interest Rate Factors

So how is interest calculated on a car loan? The interest rate you receive on your car loan will be determined by a few different factors. Your credit score, down payment, job history, and even the type of vehicle you select can all affect your final interest rate.

Credit Score

Most people know that their credit score is one of the top determining factors in what kind of rate they will receive. The lower the credit score, the higher the interest rate, and the higher the credit score, the lower the interest rate.

In general, most consumers fall somewhere in the 600-700 range. Drop below 600 or even 620, and you may have trouble finding any kind of financing. On the other hand, earn your way to a 700 or above, and you should have the top pick of many lenders with competitive rates.

Income and Employment

Lenders will also take a look at your income and employment history to determine your overall creditworthiness. They don’t want you to default on your loan, so they like to see a stable and secure job history and an income that can sustain your monthly payment. Most lenders will want to see at least a few years of solid job history as well as a low DTI (debt-to-income) ratio.

Car Selection

You may not realize that your car selection can affect your APR, but it often does. Some lenders prefer to finance newer vehicles due to their low mileage and can charge a premium for funding a used car.

In addition, there is a federal rate known as the prime rate that determines the base rate most lenders use to set their rates. The prime rate is typically around 3.5%, and lenders usually add a few points of “markup” on top of that to determine their base rate for their best and most qualified customers.

Getting The Best Rate

There are a few tips and tricks to ensure that you get the lowest rate during the car buying process.

Check Your Credit

Completing a free annual credit check can go a long way toward ensuring you have the best possible interest rate on your new car. When you have a better idea of your financial picture, you can work to change your financial health and overall creditworthiness.

If you find mistakes on your report or set a goal to pay down your debt before applying, you should be able to quickly improve your financial situation and score a shiny new low interest rate.

Shop Around

You will want to shop around to ensure that you are getting the best possible rate. Interest rates can vary widely from lender to lender. Whereas one lender might consider you at risk of defaulting on your loan, another lender could see you as the ideal candidate for financing.

Down Payment

Figure out your initial down payment before shopping for a car. You can sometimes receive a lower interest rate by placing a larger sum of money down.

How Is Interest Rate Calculated With Credit Union of America?

With Credit Union of America, finding and financing your vehicle is made easy. Our auto loans are convenient, quick, and easy, and come with no origination fees.

Visit the link below to learn more and apply for one of our great auto loan products.


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