Shopping for a new or used car often means taking out an auto loan to cover the cost. But before you sign on the dotted line, it’s important to understand how interest works on a car loan.
Your interest rate plays a major role in determining both your monthly payment and the total amount you’ll pay over the life of the loan. Knowing how it’s calculated can help you compare offers, choose the right lender, and figure out how much car you can afford without straining your budget.
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To understand how to calculate interest on a car loan, it’s important to first understand the difference between interest and annual percentage rate (APR).
Interest is the fee you pay a lender for the money you borrow. The interest rate is the percentage of the loan amount that your lender charges. For example, if you borrow $40,000 for a car at an interest rate of 6%, you'll pay 6% of the balance in interest each year until the loan is repaid.
When you shop for financing, you'll often see the APR instead of the car loan interest rate. The APR includes the interest rate and any additional loan fees. It gives you a more complete picture of what you'll actually pay to borrow money.
The best way to understand how car loan financing works is with a practical example.
Let's say you purchase a car for $40,000 and finance it for 60 months at 6% APR.
This gives you:
- Monthly payment: $773
- Total interest charged: $6,399
- Total amount paid: $46,399
If this were an interest-free loan, your payment would be $667, and you would only repay the $40,000 you borrowed. Because interest is added, your overall cost comes to $46,399 ($40,000 principal + $6,399 interest).
When you repay a car loan, your monthly payments are amortized. This means a portion of each payment goes to the principal amount, and the rest is interest.
In the early months of your loan, a larger portion of each payment goes toward the interest. As you keep making payments and your balance gets smaller, less of each payment is applied to interest, and more goes toward paying down the principal. By your final payment, nearly all of the $773 goes toward the principal.
This amortization schedule shows how your payments are divided over time:
| Year |
Interest |
Principal |
Ending Balance |
| 1 |
$2,207.62 |
$7,072.13 |
$32,927.87 |
| 2 |
$1,771.42 |
$7,508.32 |
$25,419.55 |
| 3 |
$1,308.33 |
$7,971.42 |
$17,448.14 |
| 4 |
$816.67 |
$8,463.08 |
$8,985.06 |
| 5 |
$294.68 |
$8,985.06 |
$0.00 |
The interest rate on your car loan affects both your monthly payment and the total amount you'll pay over the life of the loan. Even a difference of just a percentage point or two can add hundreds or even thousands of dollars to the amount of interest you’ll pay. That's why it's so important to shop around and compare offers from lenders.
You can easily calculate the interest on a car with an auto loan calculator. It allows you to quickly see your monthly payment and the total cost of borrowing.
This table shows how different interest rates affect the total interest paid for a $40,000 car loan over 60 months:
| Interest Rate |
Monthly Payment |
Total Interest Paid |
Total Cost of Loan |
| 4% |
$737 |
$4,200 |
$44,200 |
| 5% |
$755 |
$5,291 |
$45,291 |
| 6% |
$773 |
$6,399 |
$46,399 |
| 7% |
$792 |
$7,523 |
$47,523 |
| 8% |
$811 |
$8,663 |
$48,663 |
Lenders consider several factors to determine your car loan interest rate. They look at your financial information, the car you’re buying (new or used), and the loan details. This helps you prepare in advance to secure the best possible rate.
Your credit score is the most important factor that’s used to determine your rate. It’s based on your credit history and reflects how well you manage debt, including credit cards, loans, and other bill payments.
Generally, a credit score above 700 helps you qualify for the best rates, while a score below 600 may lead to higher costs or make it harder to get approved for financing.
This table* summarizes recent average rates for new and used car loans based on credit score:
| Credit Band |
Super Prime |
Prime |
Near Prime |
Subprime |
Deep Subprime |
| Credit Score |
781-850 |
661-780 |
601-660 |
501-600 |
300-500 |
| New Cars |
5.27% |
6.78% |
9.97% |
13.38% |
15.97% |
| Used Cars |
7.15% |
9.39% |
13.95% |
18.90% |
21.58% |
Lenders also look at your income and work history to assess your ability to repay a loan. Stable employment and a low overall debt-to-income ratio — the portion of your monthly income that goes toward your debt payments — can increase your chances of getting a better rate.
Putting more money down up front lowers the amount you need to finance, which reduces the total interest you’ll pay. A larger down payment tells lenders that you're committed to the purchase, which reduces the risk of a loan default. Most buyers put down 10% to 20% of the vehicle's price.
How long you finance a car — the loan term — also affects your interest rate. The term is usually expressed as the number of months you finance a car. For example, a term might be listed as 60 months instead of five years.
Shorter terms usually have lower rates but higher monthly payments. Longer terms, on the other hand, reduce your monthly payment but often have higher rates. With a longer term, you’ll pay more in interest over the life of the loan.
When choosing a loan term, keep in mind that your car will lose value over time. Many new vehicles depreciate about 20% in the first year and roughly 15% each year for several years. This can leave you owing more on your loan than the car is worth. It can make it harder to pay off the loan if you decide to sell.
A borrower with excellent credit might see rates as low as 5.49%:
| Term |
Principal |
Interest Rate |
Payment |
Total Interest |
| 36 Months |
$40,000 |
5.49% |
$1,208 |
$3,476 |
| 60 Months |
$40,000 |
5.49% |
$764 |
$5,832 |
| 72 Months |
$40,000 |
5.74% |
$658 |
$7,377 |
The lender you choose plays a big role in the interest rate you receive. Banks and credit unions usually offer the best rates for qualified borrowers, while dealership financing is often higher. Subprime lenders usually have the steepest rates due to the added risk.
Credit unions typically offer excellent rates and flexible terms for new and used car loans. Their rates are low because they are structured as not-for-profit financial cooperatives that are member-owned. Instead of earning profits for investors, they are focused on providing the best rates and service to their members.
This is supported by the National Credit Union Administration:
| Loan |
Credit Unions (National Average) |
Commercial Banks (National Average) |
| Used Car Loan, 48 Months |
6.46% |
7.51% |
| Used Car Loan, 36 Months |
6.35% |
7.46% |
| New Car Loan, 60 Months |
6.40% |
7.21% |
| New Car Loan 48 Months |
6.27% |
7.13% |
Conditions in the wider economy, as well as within the new and used car markets, also affect interest rates. Rates for cars generally follow the overall lending rates set by the Federal Reserve. For example, in 2019, rates averaged just over 4% according to NCUA data. In early 2024, they were closer to 7%.
Rates have also risen sharply in recent years due to a disruption in the global vehicle supply chain. A global shortage of electronic chips restricted new car production in the early 2020s, which pushed more buyers into the used car market. The surge in demand for used vehicles drove rates higher than the overall market levels.
Securing a low rate on your car loan can save you thousands of dollars over the life of the loan. By preparing ahead and knowing what lenders look for, you can position yourself to qualify for affordable financing.
Here are some things you can do:
- Check your credit: Review your credit report before applying for a loan so you can correct any errors. Reducing debt and consistently paying your bills on time will also improve your score over time and increase your chances of qualifying for better rates.
- Shop around: Compare offers from at least three different lenders to make sure you’re getting the best deal.
- Make a larger down payment: A bigger down payment reduces the loan principal you need to borrow. There is less risk for the lender, which means you may be rewarded with a lower interest rate.
- Choose a shorter loan term: Loans with shorter terms usually have lower interest rates. While your monthly payments will be higher, you’ll pay off the car faster.
- Time your purchase: Auto loan rates can fluctuate throughout the year. Shopping right before new models are released, or during slower periods, may help you negotiate a lower rate if you decide to go with dealership financing.
- Buy a newer car: Newer cars are often considered less risky by lenders because they're easier to use as collateral and they’re more reliable. That lower risk often means lower interest rates for borrowers.
At Credit Union of America, we understand that having a reliable car isn’t a luxury. It’s a necessity for work, school, and other needs. That’s why we’re committed to helping our members save on interest and get a loan term that fits their budget.
Let's talk about your financing needs. Our dedicated team will work with you to create an affordable solution that gets you on the road for less. Our auto loans always offer competitive rates and a hassle-free application process to save you both time and money.
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