Interest Rates On Cars – What You Should Know Before You Buy

3 minutes

Buying a vehicle is a significant purchase for anyone. In this day and age, you spend so much time on the road. Finding the right car and having something reliable is important. Not to mention finding a car you really want. That’s the fun part.

Before you race off to the nearest car lot, there are a few things you need to consider.

  • How much will a new car cost?
  • How much interest will I pay?
  • How do car loans work?
  • How do I get an auto loan?

Here’s the nitty-gritty on understanding auto loan interest and fees.

Firstly, there are generally two types of interest on car loans – Simple interest and precomputed interest.

INTEREST: Simple vs. Precomputed

Simple interest is when you pay interest on the balance you owe on the day your payment is due.

For example, let’s say you pay your auto loan of $20,000 with a monthly payment of $800 per month. Your first interest payment will be deducted from the full $20,000. Once that amount has dropped to say $19,200, then you will only pay interest on that amount, not the entire $20,000.

Simple interest is a good choice as it allows you to pay less interest over time. It is also an incentive to pay down portions of the principal faster. Which, in turn, saves you loads of money.

You would need to confirm that there are no prepayment penalties before doing this however as this would defeat the purpose.

Precomputed interest is when the interest for the entire loan is divided out evenly over your regular payments. The interest doesn’t change throughout the course of the loan.

A benefit using this type of interest is that your payments will stay the same throughout the loan.

The negative with this type of loan is that there is no point paying the loan off faster to save money on interest.
Compare car loan rates here

Amortization

Most auto loans are amortized. Amortization can be explained as spreading the payments of principal out over the loan period.

With lower principal payments throughout the first part of the loan and higher principal payments at the later end of the loan.

What does this mean for you? Your payments don’t change, just how much the lender assigns to the interest vs. the principal changes throughout the loan.

Initially, the majority of your payment will go towards interest. The other small portion will pay off some of the principal of your loan. The roles reverse as the loan draws closer to the end date.

Why do they do this? Well, Amortization is an accounting term that periodically lowers the value of the item, or in this case, a vehicle.

It’s kind of a safety net for lenders to hold a higher equity portion in the car earlier on in the loan. This reduces the risk for the lender.

Vehicles are depreciating items and are therefore considered a higher risk loan as opposed to say a home mortgage where the property would usually go up in value.

PRO TIP: Try gaining preapproval from one lender before shopping around. You may find that other lenders may lower their interest rates to close a deal. It doesn’t always work, but it’s worth shopping around.

Interest Rate vs. Annual Percentage Rate (APR)

When you get to the stage of comparing auto loan quotes from different companies, make sure you are comparing apples with apples.

The interest rate is the amount you pay each year to borrow the money. This usually displayed as a percentage.

Interest is important to view; however, interest rates alone don’t factor in all the other lending fees.

What you need to look for is the Annual Percentage Rate (APR). This rate is what you are actually going to end up paying.

The APR includes the interest rate annually as well as all fees associated with the lending.

All lenders are required to disclose the APR on a loan offer, so be sure to compare those rates to get an accurate calculation.

Our auto loan calculator tool is a great way to start getting accurate quotes from many lenders. The calculator tool is completely free to use and gives instant initial comparisons.

New vs. Used

Lenders tend to charge higher interest on used vehicles. This is because they are considered a depreciating asset.

Older cars have a higher chance of breaking down and needing repairs. You don’t have to have as high of a credit score to get a reasonable interest rate on an auto loan when it comes to a used vehicle.

Your credit score needs to be up around 719, to get the lowest interest rate on a new vehicle auto loan.

Keep in mind that 5.6% interest on $15,000 (used car) loan is still a lot less than 4.2% interest on a $30,000 (new car) loan.

In a nutshell:

Figure out what you can pay per month within your budget. Put down as much of a down payment as possible to reduce the loan amount required, as it will save you big time on interest. Shop around and compare APR with APR.

If you’re ready to compare auto loan rates here is a great place to start.

We want to hear from you. If you have any other tips when comparing lending on cars, be sure to leave a comment below.

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