Credit Union of America - How Is Interest Calculated on a Car Loan?

If you’re buying a new car, you’re most likely financing it with an auto loan. If it’s your first loan you probably have questions about how interest rates work, how APR is calculated, and how these and other factors will affect how much you end up paying on your loan.

In this blog, we explore some of the factors that affect your car loan, your monthly payments, and the overall cost of your loan. Read on to learn what you should know about how car loans are calculated.

How Does Car Interest Work?

Your auto loan interest rate is the premium your lender charges to extend you the money to buy your car. Also known as the cost of borrowing, it is the percentage of the amount you borrow that you owe on top of the principal that you must pay back.

How Does Interest Work On An Auto Loan?

How does it work? Say you borrow $25,000 to pay for a car over five years (60 months). At a rate of 10%, you would theoretically pay $2,500 over the life of the loan. However, because the interest is compounded monthly — that is charged to the loan amount and then recalculated at the higher total — you’ll end up paying much more: $30,489.60.

As we will see, the interest rate you are charged adds a significant amount to your borrowing over time. The lower the rate, the less additional money you’ll need to pay over and above the sticker price of your car.

How To Calculate APR On A Car Loan

Lenders tend to talk about an annual percentage rate (APR) instead of just an interest rate on a loan. Your APR is the amount you will pay on your loan measured over a single year rather than the life of a loan. It excludes annual fees or other auto loan charges.

APR sometimes includes the effect of compounding – that is, the effect of charging interest to the principal each month and then reapplying the interest rate. In the example above, the effective APR including compounding would be 10.47%, but where this is excluded APR should be the same as your overall interest rate.

How to Calculate the Interest Rate on a Car Loan

Now let’s take a closer look at how different interest rates affect both your monthly payment and the total cost of borrowing over the full term of the loan. As you will see, even a small increase in your interest rate affects your monthly bill and has a dramatic effect on the total amount you end up paying over the life of your loan.

The following table illustrates the typical effect of different interest rates on a loan of $15,000 over five years.

Interest Rate	Monthly Payment	Total Interest Paid	Total Cost of Loan
5%	$283	$1,980	$26,980
7.5%	$301	$3,052	$28,052
10%	$318	$4,075	$29,075
12.5%	$334	$5,248	$30,248
15%	$357	$6,423	$31,423

Factors Affecting Interest Rates

It pays to secure the lowest possible rate you can to make your car more affordable. Now let’s focus on the major factors that lenders consider when calculating your interest rate.

Credit Score

Your credit score is the most important factor determining the interest rates you pay. Your score is based on your credit history, compiled by credit bureaus which track closely how you manage your existing debt including credit cards, bills, and personal loans.

Generally speaking, a score above 700 will qualify you for the best rates, while a score below 600 will result in higher rates or difficulty in securing financing. The following table* summarizes recent average rates offered 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	5.38%	6.89%	9.62%	12.85%	15.62%
Used Cars	6.80%	9.04%	13.72%	18.97%	21.57%

*Source: Experian State of the Automotive Finance Market report, Q1 2024

Income and Employment

Lenders also look at your income and job stability to assess your ability to repay a loan. A stable job history and a low overall debt-to-income ratio – your monthly earnings versus your monthly debt payments – can improve your chances of getting a better rate.

Down Payment

Being able to make a larger down payment reduces the amount you need to borrow, which can help to reduce the interest you pay. Lenders like it when borrowers “have skin in the game” by taking a stake in the vehicle. Down payments between 10% and 20% are common.

Loan Terms

The length of your loan terms is also tied to your interest rate. Shorter terms typically have lower rates but higher monthly payments. You can lower both your interest rate and your monthly payment by taking a longer loan term, but you will end up paying more interest over the life of the loan because you are paying over a greater number of months.

Remember also that the value of your car depreciates rapidly over time. As a rule of thumb, many new autos are considered to lose 20% of their value in the first year and a further 15% every year after that up to about five years out. Owing more on your car than your car is worth is a dangerous situation because you can’t sell your car to settle your debts.

Here are some sample rates based on recent figures for a borrower with excellent credit.

Term	Principal	Interest Rate	Monthly Payment	Total Interest
36 months	$25,000	4.5%	$744.44	$1,800
60 months	$25,000	5.5%	$478.32	$3,699.20
72 months	$25,000	6.6%	$418.71	$5,148.96

Lender Type

The type of lender you choose for your loan will also affect your interest rate. Banks and credit unions typically offer the best rates for qualified borrowers, while dealers may charge more through specialist financing houses. Those forced to seek financing from subprime lenders generally end up paying higher interest rates.

Credit unions have a good reputation for providing good rates and flexible terms for new and used car sales. As financial cooperatives owned by their members, credit unions like Credit Union of America have less incentive to maximize profits through higher rates and extra fees and more incentive to lend money on terms that their borrowers can afford.

Recent figures released by the National Credit Union Administration support this.

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, 48 Months	6.40%	7.21%
New Car Loan, 36 Months	6.37%	7.13%

Source: NCUA

Market Conditions

Conditions in the wider economy as well as within the new and used car markets also affect interest rates greatly. Rates are likely to track the overall lending rates managed by the Federal Reserve. For example, in 2019, typical rates averaged just over 4% according to NCUA figures. In early 2024, they were closer to 7%.

Rates have also risen sharply in recent years due to disruption in the global vehicle supply chain. A global shortage of electronic chips restricted new car production, particularly in the early 2020s. This in turn placed additional demand on the used car market, causing rates above wider market rates there to rise there too.

How To Get The Best Auto Loan Rate

What can you do to get the best rate for your new or used car purchase? Here are some handy tips for securing a better rate on your auto loan.

Check your credit: Routinely checking your credit report, and well before applying for a loan will allow you to correct any errors. Reducing your debt and paying bills on time will improve your score over time and help you qualify for better rates.
Shop around: As we have seen, interest rates vary widely among lenders. Comparing offers from at least 3-4 different lenders can help ensure you get a good deal.
Make a larger down payment: A larger loan payment is always a good idea if you can afford it. The more money you put down upfront, the more of your car you’ll own outright, and the lower your loan principal and interest rate will be.
Choose a shorter loan term: Opting for a shorter-term loan will lower your interest rate. You will pay more interest each month but your car will be yours sooner and you will pay less interest overall.
Time your purchase: Car interest rates do vary throughout the year. Buying just before new models are released or outside the peak buying windows during summer and over public holidays may allow you to negotiate a lower rate from dealers.
Buy a newer car: While it might be tempting to buy the lowest-priced car you can afford, sometimes buying a somewhat newer car will let you qualify for a lower rate. You’ll get a nicer vehicle and you may end up paying less overall in interest payments.

Get Rolling for Less With Credit Union of America

At Credit Union of America, we know how important a car can be to get you where you are going in life. That’s why we work closely with our members to get them the reliable, affordable transportation they need.

Talk to us about your car financing challenges. We’ll work with you to create an affordable package to get you on the road. Our auto loans always offer competitive rates and are designed to be quick and easy to apply for and to provide a manageable loan balance over the long term.

SEE OUR GREAT LOW RATE AUTO LOANS

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