Buying a car is usually the second largest expense in life after a house. Many people only look at the “price of the car” and after signing the contract, they realize that the monthly payment, taxes, and interest on the loan are much higher than they expected. In this article, you will learn how a car loan payment is calculated and what factors affect it. Then you can try out different scenarios in seconds with the calculator at the top of the page.
What are car loan installments made of?
Five main factors determine your monthly payment:
- Car Price: The basis for everything.
- Down Payment: The higher the down payment, the lower the loan amount and interest.
- Trade-in Value: If you trade in your old car, it will be deducted from the loan amount.
- APR: The annual percentage rate that the bank or lender charges, which depends on your credit score.
- Loan Term: Usually between 24 and 84 months.
Sales tax is also added to the price in many states and is usually included in the loan amount. That’s why we have a separate field for it in the calculator.
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Calculation formula (for the curious)
Monthly payments are calculated using this standard formula:
In this formula, M is the monthly payment, P is the loan amount, r is the monthly interest rate (APR divided by 12), and n is the number of months. If the interest rate is zero, it becomes simpler: the loan amount divided by the number of months.
Practical example
Suppose you buy a car for $30,000, put down $3,000, have a 6% tax rate, and a 7% interest rate for a 60-month term. The final loan amount is about $28,800, and the monthly payment is about $570. Now increase the term to 84 months: the payment will be lower, but the total interest will be significantly higher. Try this yourself with a calculator.
Why isn't a long-term loan always cheaper?
The installment is less tempting, but a 72- or 84-month loan means you pay interest for a longer period. The car also loses value over the same period. The result is a situation where your debt is more than the car's actual value (this is called negative equity). If you have to sell the car early, you will lose money.
6 tips for getting a better loan
- Get pre-approval before going to the exhibition. Get an interest rate from your bank or credit union so that you have bargaining power.
- Increase the down payment as much as possible. At least 10 to 20 percent of the price is suggested.
- Check your credit score. Even a few percent difference in interest rate will cost a lot during the loan.
- Choose a shorter loan term. As long as the installment is bearable for you.
- Don't just pay attention to the monthly installment. Compare "Total Total Payments," not just installments.
- Don't forget the extra costs. Insurance, fuel, maintenance and registration are included in the monthly fee. (Here is the link to the article "The real cost of car maintenance")
Rule 20/4/10
A popular rule of thumb for choosing a car: at least 20% down payment, a maximum loan term of 4 years, and total car costs (payment, insurance, fuel) less than 10% of gross monthly income. This is not a rule, but it is a good starting point for making a decision.
FAQs
How is a car loan payment calculated?
Based on the loan amount, annual interest rate, and number of months. The calculator at the top of the page does this automatically.
Is this calculator accurate?
The result is an estimate. The final amount also depends on fees, mandatory insurance, and the lender's terms.
How much should the down payment be?
Usually, 10 to 20 percent of the car's price is recommended. The higher the amount, the less interest you'll pay.
Is a 60-month loan better or a 72-month loan?
A 72-month loan has fewer payments but more total interest. If your budget allows, choose a shorter term.
Is sales tax included in the calculation?
Yes, enter your state's tax percentage in the appropriate field.
Before signing any contract, try out a few scenarios with a calculator: compare different down payments and terms, and look at the “total payments,” not just the monthly installment. It takes a few minutes and could save you thousands of dollars.