Auto Loans

How to Calculate Interest on Your Car Loan

Ever wonder how the figures on your loans are calculated? When it comes to auto lending, there are specific equations and number-crunching that go into factoring in your interest and your monthly payments.

Here are some basics to know about how your car loan functions, mathematically speaking.

1. The Lender Buys

If you need a loan to purchase a new car, your lender actually purchases the car for you and allows you to pay it back over a period of time. This is not dissimilar to how loans work with homes or even college tuition. Basically, your lender gives you its money, and, in exchange, you compensate the lender for its services by paying interest.

2. Interest is Simple (Usually)

Most car loan lenders (Sioux Falls Federal Credit Union, included) use a simple daily interest to calculate your accruing debt over time. With this type of interest, charges are calculated only on the principal (the original amount owed on a loan). Simple daily interest does not compound on interest, which generally saves you money.

3. Your Payment’s Target Varies

Simple daily interest does not necessarily mean, every time you make a payment on your loan, that you pay equal amounts of interest and principal. Instead, most car loans are paid down via amortization, meaning you pay more interest at the beginning of your car loan than at the end.

Here’s how that looks in an example:

Let’s say you take out a car loan for $15,000 to be paid back over five years (60 months) at an interest rate of five percent. Your monthly payment for this loan would be $283.07.

Each month, if you make your payment on time and for the full amount, your interest amount goes down and the principal amount paid on your loan goes up.