How Does Interest Work on a Car Loan?

If you’re buying your first car and plan to take out a loan, you’ll want to pay attention to more than just the sales price. The interest rate you’re offered on your car loan is equally important. By gaining a full understanding of how interest rates work, you could save big money in the long run.

Here’s what you need to know about auto loan interest rates, along with tips on how to get the best possible rate for your next ride.

What Is a Car Loan Interest Rate?

When you take out a car loan, you agree to pay back the loan amount plus interest—a charge for borrowing the money—over a specific period of time. The interest rate on the auto loan determines how much interest you’ll pay. Typically, your car loan interest rate will be a percentage of the amount you borrow.

Car loan interest rates come in 2 types: fixed and variable. A fixed interest rate remains the same throughout the life of the loan, while a variable interest rate may change according to market fluctuations. Fixed-rate auto loans are more common and add stability to your monthly payment schedule.

How Is Annual Percentage Rate (APR) Different From Interest Rate?

While both forms of interest are usually represented as percentages, the interest rate of a loan is what a borrower pays to borrow the money from their lender and would be lower than the APR when additional loan-related fees are involved. Those fees added to the interest rate would give you the APR. So, when comparing loan rates, it may be beneficial to look at the APR of each, to get a better understanding of the total amount you’d have to pay. It’s also fair to say that the APR could be the same as the interest rate if no additional financing charges applied.

Factors That Can Affect the Interest Rates on Your Car Loan Repayment

Here are some factors that your lender may consider:

• Credit score – Your credit rating, as determined by the major credit reporting agencies
• Down payment – How much money you pay the car dealer or seller upfront at the time of sale. Then, the loan amount is applied to make up the rest of the purchase price.
• Loan term – The length of time you have to pay off your loan

Auto loan interest is usually calculated using “simple interest,” which means it only applies to the amount you borrowed (your principal loan amount). This is important, since it means the interest added to your balance won’t also accrue interest—which saves you money! However, it’s not as simple as applying a percentage to your loan amount upfront. In most cases, car loan interest is calculated based on your loan balance each month.

This means several important things for your repayment plan:

• The amount you pay toward interest will be higher at the start of your loan (since you have a larger balance) and lower at the end of your loan repayment period.
• Longer-term loans typically have higher interest rates and generate more interest than shorter-term loans. Even if your monthly payment is lower on a long-term loan, you may end up paying more in the end due to interest.
• If you pay more than the minimum payment each month, you’ll reduce your loan balance and, in turn, reduce the amount of interest you pay. This may incentivize you to pay off your loan early to save money.

Your car loan interest rate plays a big role in determining how much you’ll ultimately pay for your car, both on a monthly basis and over the life of your loan. Because of this, you’ll want to find the lowest interest rate possible for your auto loan.

How Is Interest Calculated on a Car Loan?

Car loan interest rates fluctuate over time, but not everyone is eligible for the same rate. The interest rate you’re offered will be calculated based on several factors, including your principal loan amount, credit score and loan term.

A higher credit score may result in a lower interest rate because you, as the borrower, represent less risk to the lender. Similarly, the loan’s repayment period can affect the interest rate; shorter loan terms usually have lower interest rates. And, the interest rate is often higher for used vehicles compared to newer ones.

You can use online calculators like Navy Federal’s Auto Loan Calculator to see what your monthly payment could be with different interest rates and our Car Loan Comparison Calculator to see how different interest rates and loan terms impact your overall repayment.

What Is a Good Interest Rate for a Car?

There is no set standard as a “good interest rate”, and the best rates vary significantly depending on factors like your credit score. To get the best rate, it’s important to choose and research the best car loan for your situation.

Tips for Finding the Best Car Loan Interest Rate

As you figure out how you’ll finance your next car, don’t be afraid to do some research and shop around. Remember: The lower your interest rate, the less you’ll pay in total for your next vehicle. Use these tips to get the best possible car loan interest rate.

• Improve your credit score: A high credit score shows lenders that you’re a responsible borrower. Before applying for an auto loan, check your credit score and history for errors, lower your debt usage and put effort into making on-time payments.
• Shop around for lenders: Different lenders offer different interest rates on auto loans. Credit unions, like Navy Federal, often have lower interest rates than banks and online lenders, and also offer personalized service and a variety of other benefits. Don’t settle for the first offer you receive at the dealership; spend some time comparing loan offers and determining your best move.
• Increase your down payment: The more money you put down upfront, the less money you’ll need to borrow on your loan. A larger down payment may result in a lower interest rate and can reduce the amount you pay in interest.
• Shorten your loan term: Shorter loans usually have lower interest rates than longer-term loans. Although a shorter loan term may come with higher monthly payments, you’ll typically pay less in interest over the life of the loan.
• Get preapproved for a car loan: Getting preapproved for a car loan means that a lender has already approved you for a particular loan amount and interest rate. This step can help you determine what type of vehicle you can afford, and it can also help you negotiate with the dealer.

Get Ready for Your Next Auto Loan

Understanding how car loan interest rates work could help you get a better deal on your auto loan. By applying these tips, you could finance your next car loan at a competitive interest rate and save money on interest.

Navy Federal offers great rates and a wealth of resources to members shopping for their next ride. We’ll help you learn how to apply for an auto loan, calculate your monthly payments and go into the car-buying process with confidence.