How to Figure Interest on a Car Loan

Interest is an essential part of your auto loan. You can find out how much interest you’ll pay over the life of a loan by using a few different factors, including the length of the loan, the amount of principal and the interest rate. 

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Knowing how to add interest into an auto loan will help you understand the true cost of borrowing. Then you use that info when making financial decisions, such as how to budget your money or whether it’s time for an auto refinance.

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Key takeaways

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• Figuring out the interest on a car loan requires knowing the principal loan amount, length of the loan term, and the interest rate.
• Car loans usually use one of two methods to calculate interest: simple interest or precomputed interest.
• There are several ways to lower your interest costs, including by paying extra on your car payment each month or refinancing your auto loan for a lower rate.

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How is interest added to an auto loan?

There’s more than one way to calculate interest on an auto loan. Lenders use two common methods: simple interest or precomputed interest. Here’s how they work.

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Simple interest

Simple interest car loans are the most common kind of auto loan. With this method, you’re charged interest on your loan’s remaining balance — not the original amount you borrowed.

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This means every time you make a payment (or extra payment) decreasing the principal, your interest charges get smaller too. Auto loans are amortized, which means you’ll pay more in interest at the beginning of the loan and less interest toward the end. 

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Precomputed interest

Loans with precomputed interest are less common. With this setup, the lender figures the total interest you’ll owe over the life of the loan, then divides it up equally across all your loan payments.

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In other words, every monthly payment includes the same amount of interest, no matter how much you pay off early. 

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How to count car loan interest

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If you're trying to understand how to add interest into an auto loan, it helps to see an example:

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Suppose you have a loan of $20,000 with a 10% interest rate and a five-year (60-month) term. Each month, you pay $424.94. To calculate the interest, you could use an auto loan calculator, or you could do the math by hand. 

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• Start by multiplying the principal and interest: $20,000 x 0.10 = $2,000
• Next, divide the result by 12 to find your interest for month one: $2,000 / 12 = $166.67

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So the first month, your payment is made up of $166.67 in interest and the rest, $258.27, in principal. This reduces your principal from $20,000 to $19,741.73, which is the number you’d use to calculate interest for month two. As you pay down the principal, the interest becomes less. By the 60th payment, the split is $3.51 interest, $421.43 principal. 

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By the end of the loan, you would have paid a total of $25,496.45: $20,000 in principal and 

$5,496.45 in interest.

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Factors impacting your car loan interest

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The average auto loan interest rate is 6.35%, according to 2024 data from Experian Automotive. However, the rate on your auto loan or refinance could be higher or lower, based on different variables. The key to figuring out interest on a car loan is knowing what your rate is and why. 

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Here are some of the factors that could affect your car loan interest:

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• Current interest rates: The overall interest rate environment plays a role in how much you’ll pay in interest. When rates are high for everyone, they’ll be high for you, too. 
• Your credit history: Your credit score and history of repaying your loans tells your lender what kind of borrower you are. If you have a lower credit score, the lender will charge a higher interest rate. That means you’ll wind up paying more over time.
• Down payment: A bigger down payment could mean a lower interest rate, while a tiny down payment could mean a higher interest rate. That’s because lenders view small down payments as a bigger risk that you could default.
• Loan amount: The more you borrow, the more interest you’ll pay, all else being equal. If you want to pay less in borrowing costs, you’ll need to borrow less.

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Ways to lower the interest on your loan

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Once you know how to figure interest on a car loan, you can explore strategies to reduce the cost. Some you can use before you get the loan, and some you can use after.

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• Improve your credit score: Paying your bills on time, consistently, is a great way to raise your credit score before you apply for a new car loan or refinance. With a higher credit score, you may qualify for a low interest rate.
• Choose a shorter loan term: Longer loan terms tend to have higher interest rates to compensate for the increased risk that you may not be able to repay the loan in full. If you want to cut down on interest costs, choose a short loan term instead.
• Make a larger down payment: If you can swing it, increasing your down payment could bring down your interest rate. It also reduces the amount you need to borrow, which in turn lowers the overall interest you’ll have to pay.
• Make extra principal payments: Once you have the loan, making extra payments can reduce the amount of interest you pay. You can make larger payments on your regular due date (making sure the lender applies the extra to your principal). Another option is to make half a regular payment every two weeks instead of your full payment once a month. 
• Refinance your auto loan: Refinancing is a good way to lower your interest rate. Since refinancing replaces your existing loan with an all-new one, you have the ability to choose different loan terms for the new loan.

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FAQs

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Here are some frequently asked questions about how to add interest into an auto loan.

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How do I add interest to a car loan?

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Most car loans use simple interest. To calculate that, you’d take 1/12 of the interest rate and multiply it with the remaining balance on your loan. You can also use an auto loan calculator to find out what you’ll pay in interest on a car loan.

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What happens if I pay an extra $100 a month on my car loan?

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Paying an extra $100 each month on your car loan will help you pay off your loan faster and save you money on interest by reducing your remaining principal. 

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Do dealers get to add interest on their loans?

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Some dealers may mark up the interest rate they offer and pocket the difference. If you want to find a lower interest rate, it’s smart to shop around, negotiate, and choose the lender that offers the lowest rate and best terms for your situation.

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