How to Calculate the Interest on a Car Loan
If you decide to take out a car loan for your new vehicle, you will have to pay interest while you also repay the loan. The interest rate you get will affect how much you end up paying back in total for your car. Find out more about what interest is, how it works, and how to calculate the interest you’ll pay on your car loan.
What is Interest?
Any time you take out a loan (unless it’s from the bank of Mum and Dad), you will need to pay back not just the borrowed amount but additional interest.
Interest is the fee charged for using someone else’s money to pay for goods or services. You haven’t saved up enough money to buy the item outright, so you need to pay a fee to the person or entity you borrow the money from.
Your repayments on a car loan, therefore, cover not just the cost of the car you purchased but also the interest.
What is Amortisation?
You may have heard of the term ‘amortisation’ in relation to your car loan. This simply refers to the method of paying off debt through regular instalments that go towards both the principal and the interest. Initially, a higher percentage of the standard regular payment goes towards interest. As you pay off more of the loan, more of your payment is put towards the principal.
How Much Interest Will I Pay on My Car Loan?
The total interest you end up paying depends on a number of factors, including:
Principal Amount Borrowed
The principal amount borrowed is the amount of money you need to borrow to buy your new car. For example, if you are purchasing a car that costs $12,000, your principal amount will likely be $12,000.
Term of the Loan
How long do you think it will take you to pay off your car loan? Opting for a shorter loan term will mean that you have to pay off more of the loan per week, but you’ll incur less interest overall. A longer loan term allows you to make lower weekly payments, but you’ll end up spending more on interest.
Let’s keep using our $12,000 car loan as an example. Using our car loan repayment calculator, you will find that on your loan of $12,000 at 7.95%, you could choose an option such as one of the following:
15 Months: $200 a week, paying interest of $596 across the life of the loan
56 months: $60 a week, paying interest of $2,334 across the life of the loan
How Repayments Work
Remember that when you make your payment of $200 per week towards your loan, not all $200 goes towards the principal amount. Part of it will go towards paying the interest on the loan. An interest rate calculator will help you to figure out how much of your payment goes towards the principal and how much goes towards interest.
So, the formula of 12,000÷200 will not give you an accurate picture of how long it will take to pay off the loan because it doesn’t account for paying interest.
How to Calculate Interest on a Car Loan
To calculate the interest you’ll pay on your first car loan payment, you can use the below formula. However, you’ll likely find it a lot easier to just use a car loan repayment calculator to figure out how much your payments might be.
(Interest rate ÷ number of payments) x loan principal = interest
Let’s continue to use the example of our $12,000 loan with 7.95% PA in interest. For the sake of simplicity, let’s say we want to pay this off in a year with monthly payments.
- First, you divide the interest rate by the number of payments you will make. 0.0795÷12 = 0.006625
- Then you multiply this result by the amount of loan principal. 0.006625 x 12,000 = 79.5
- So, the amount of interest you will pay in your first repayment is $79.5
You can use this formula to figure out each payment; just make sure to update the principal amount to reflect the repayments you have already made.
You can do this by subtracting the interest paid from your repayment amount. That will show you how much you have paid off on your loan principal. Subtract this from your principal to see what the new balance of your loan is.
As you can see, figuring out how much interest you pay in each payment across the life of the loan would take you a lot of time and leave a lot of room for errors. So, we recommend using an interest rate calculator instead to ensure accuracy.
As the principal amount of the loan reduces over time, the amount of your repayment put towards interest will also decrease.
That’s why you pay more interest at the start of your loan term than at the end, although the interest rate remains the same.
Need a Car Loan?
If you need a car loan, Stadium Finance is here to help with competitive interest rates. We offer easy to understand repayment schedules and flexible payment options. Figure out how much you can afford to repay each week and apply online for your loan. You’ll receive a decision within a matter of hours so that you can go out and begin the search for your new vehicle. You could be driving off in your new car in no time! Contact our friendly team today to find out more or apply online now.