3 factors affecting your car loan payment

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In a Nutshell

Three major factors that determine your monthly car loan payment are your loan amount, the interest rate and the loan term. There are steps you can take — like making a down payment, improving your credit or choosing a different loan term — that can help reduce the amount you pay each month.

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A car is likely one of the biggest purchases you’ll make. That’s why it’s important to understand exactly how much you’re paying for it and how that amount is determined.

When you get approved for a car loan, the lender will give you an amount of money that you pay back, with interest, over an agreed-upon period of time (typically three to seven years).

Your car loan payments are broken down into monthly installments, and the price of those installments is largely determined by your loan amount, interest rate and length of your loan term.

Let’s take a deeper look at how each factor can influence your monthly car loan payment, what ways you can potentially save money on your car loan and how to calculate your monthly payment.


1. Car loan amount

The amount of money you need to borrow can be determined by whether you still owe money on your current car, the purchase price of the vehicle you’re buying, the amount of your down payment and if you have a car you’re trading in.

If you still owe money on your current car, some lenders will let you roll over the balance into your new loan. But this can be a risky move, because when you do this you’ll likely become upside down on your car loan. When you’re upside down, your car’s market value is less than what you owe on your loan.

If you own your vehicle outright, trading in your current car can work for you.

If you plan to buy a new car from the dealership where you’re trading in your current vehicle, the dealer may give you a credit for your car’s trade-in value. Then you can apply that credit toward the cost of your new car.

And if you’ve sold your car to a dealership but don’t plan to buy there, you’ll typically get a check for the value of your trade-in that you can use as a down payment toward your new car purchase. Both the check or trade-in credit can bring down your loan amount and maybe even your monthly payment.

For example: If you want to buy a $25,000 car with no trade-in or down payment, excluding sales tax, your monthly payment on a five-year auto loan with a 5% interest rate would be around $472. But if you got a credit of $7,000 for your trade-in, your monthly payment would drop to about $340. That’s a savings of $132 per month.

If you want to drop your loan amount but don’t have a vehicle to trade in or you aren’t able to make a substantial down payment, try negotiating the car price at the dealership.

2. Interest rate

Your monthly car payment serves to pay down the loan’s principal, as well as interest and fees. The higher your interest rate, the higher your monthly payment will be.

Let’s say you’re able to get a lower interest rate of 4% on that five-year $25,000 loan. With no down payment (and excluding sales tax), your monthly payment would drop from $472 to $460 — a savings of $12 per month and $720 over the length of the loan.

But how can you qualify for lower rates?

Auto loan rates are determined by several factors, such as your credit, income, debts, loan amount and loan term.

Generally speaking, the better your credit, the lower your interest rate can be.

What’s the minimum credit score needed for an auto loan?

Lenders can also look at your debt and income. If you’re carrying too much debt, the lender may decide to charge you a higher interest rate (or require a shorter loan term or a larger down payment).

Here are a few ways you may be able to get a lower interest rate.

  • Wait to build your credit before buying a car. Making on-time payments and reducing debt are two key ways to work on improving your credit.
  • Shop around and compare offers. Car loans are available through dealerships, banks, credit unions and online lenders. Applying for preapproval from multiple lenders before you go to the dealership lets you compare the loan amounts you might be approved for, as well as estimated interest rate and loan terms, across lenders. Just be aware that a preapproval is not a guarantee that you’ll actually get the loan on those terms.
  • Refinance down the road. If you improve your credit later on, you may want to consider refinancing your car loan to see if you can get a lower interest rate.

3. Loan term

With a shorter loan term, your monthly car loan payment will likely be higher — because you’ll pay off the loan balance with fewer monthly payments.

If you took out a $25,000 loan with a 4.5% interest rate and six-year term instead of a five-year term, you’d pay $69 more per month with the shorter loan term.

But keep in mind that, in this scenario, the extra 12 months of payments means another 12 months of interest, too. The additional interest would add about $608 to the total cost of your car.

In addition to paying more interest, you may also pay a higher interest rate with a longer loan term. Loans of six years or longer can have higher interest rates than shorter-term loans.

When deciding on what loan term length is right for you, consider your overall budget and financial situation. But if you want to save on the total amount you pay for your car, you may want to stick with a shorter loan term or opt for a less-expensive car.

How do you calculate a loan payment?

Your loan amount, interest rate and loan term are all used to calculate your monthly car loan payment. You can calculate your estimated monthly payment with an online loan calculator or by using an Excel formula.

1. Type the following formula into a cell: =PMT([interest rate as a decimal]/[12 for the number of months in a year], [number of months in your loan term], [loan amount plus any fees], [final value])

2. The resulting negative number is your estimated monthly loan payment. (Remember to remove the minus sign in front of the number.)

If sales tax isn’t included in your loan amount, remember to account for that cost, too.


What’s next?

Your monthly car loan payment is largely affected by your loan amount, interest rate and loan term. Your credit, debt and income can play a key role in determining your overall loan cost, so it’s important to know your current credit and take steps to improve it, if necessary.

Your monthly payment is an important factor to think about when you’re deciding if you want to purchase a car and take out a loan — but it’s not only the only consideration. The loan’s interest rate and terms can also have a significant impact on the total amount you end up paying for your car. And be sure to account for the other car ownership costs — beyond your car loan payment — as you establish your auto budget.