How do I calculate interest on a car loan?

For the majority of Canadians, putting down the entire cost of a new vehicle in cash isn't an option, which is where auto loans come into play. Like any type of loan, shopping around and comparing interest rates can help you save money over time and lower your monthly payments. To learn more about how you can calculate interest on your car purchase, stick around.

What is an interest rate?

First things first, what exactly is an interest rate, and why does it matter? An interest rate is the amount of money you'll pay on top of the initial money borrowed from a bank or credit union to fund the purchase of your new vehicle. The specific interest rate you are offered by your lender reflects your risk profile when borrowing money.

To calculate interest, a lender will consider your credit score, your down payment amount, credit history, and debt-to-income ratio. Ultimately, car buyers with a higher credit score are likely to receive more favourable car loan interest rates than those with poor credit.

Simple interest auto loan

Now, when it comes to your car loan interest, there are two ways it can be calculated. The first is using a simple interest rate method. With a simple auto loan interest rate, you'll only be charged interest on the principal amount you've borrowed.

For example, if you borrow $20,000 and your annual percentage rate (APR) is 5% over 60 months, your monthly interest payment would be $83.33 until the loan balance has been paid off fully. This equates to $5,000 in total interest paid over the life of the loan.

Most of the time, auto financing will use a simple interest calculation.

Compound interest car loan

The second method used to calculate car loan interest is a compound interest rate. This type of interest rate is calculated based on the principal amount borrowed and any accumulated interest over time, meaning you'll pay more interest on your loan amount than with a simple auto-interest rate.

Using the same example as above, the total interest paid for a compound interest rate on your car would be $25,525.63. While this auto loan interest is much higher, you do have the ability to pay off your principal amount faster.

How to calculate the interest rate on your car loan

Calculating the interest in a car can benefit car buyers and help in the decision-making process when choosing to purchase a new car or a used one. Luckily, there are several ways you can calculate auto loan interest, including the following:

Use an auto loan calculator

The easiest way to calculate your auto loan interest is by using an online auto loan calculator. There are numerous loan calculators available for you to try. With these, you'll be able to play around with the amount you put down as your down payment, the length of your loan term, monthly interest and your monthly payments.

By doing so, you can get a better idea about how much your loan amount should be and the type of vehicle that would work best for your finances.

Calculate your monthly payment yourself

The next way you can calculate interest on your total loan is by doing the calculations yourself using this formula: Your monthly payment = (interest rate/12) x current loan balance. Just make sure that your interest rate is expressed as a decimal. For example, a 7% interest rate would be 0.07.

Speak with your lender directly

Lastly, whether you're taking your loan using dealer financing, credit unions, or your bank, speak with them directly. They'll be able to calculate your monthly interest based on your loan principal, down payment, and trade-in value. They may also be able to help you lower monthly payments, depending on your financial situation.

Can I Save Money Buying An Electric Vehicle?

"Can I save money buying an electric vehicle?" is a question you may have if you're considering switching from a gas-powered vehicle to an electric one. The cost of an electric vehicle will depend on what make and model you choose and the car brand you're shopping with. That said, there are several provincial rebates available for which you may qualify.

Keep in mind that rebates will vary between provinces.

Factors impacting interest rates

When determining your loan terms and interest rates, there are several factors car dealers will consider, including the following:

Credit scores

Your credit score, of course, is one of the most important factors a dealership will look at. Whether you're working with them directly or not, your credit score will determine what your risk profile is when borrowing money, which directly impacts the interest costs you'll pay.

Debt-to-income ratio

Your debt-to-income ratio indicates how much of your monthly salary is put towards credit card debts, mortgages, and other loans. Those with a debt-to-income ratio that's above 30% may be charged more in interest costs than those with a lower ratio.

Loan repayment term

While you may benefit from lower monthly payments, the longer your loan length is, the more interest you'll pay in the long run. Make sure your loan term is reasonable so you don't end up paying more in interest than the purchase price of the vehicle itself.

Down payment

To lower your loan amount and make your vehicle more affordable, ensure that your down payment is large enough that it lowers your total interest paid over time. Ultimately, a larger down payment will help lower the amount you need to borrow.

New or used car

Based on your current financial situation and how much your down payment is will determine whether you can afford to purchase a new car or a used car.

Loan amount

Depending on your credit score, you may pay more interest on larger loans and less interest on smaller loan amounts.

What other ways can I finance my new car?

There are other ways to finance your car purchase if you don't want to take out a conventional auto loan. You may decide to take out a personal loan rather than a vehicle loan. Since personal loans are not secured, you won't be required to provide security in the event that you are unable to repay the loan. You might also be able to get a better interest rate by doing so, depending on your financial institution and credit history.

A line of credit is another option. Credit lines function similarly to credit cards in that you only pay interest on the amount you borrow and can spend up to your credit limit. Lastly, rather than purchasing a vehicle and taking out a loan, leasing may be better for your financial situation. With leasing, you'll have the ability to have lower monthly payments and the opportunity to drive a newer model car. At the end of your lease, you'll have the opportunity to purchase the vehicle for its current depreciated cost or sign another lease for a different vehicle.

What is the typical interest rate for a used vehicle in Canada?

The interest rates for used car loans will be higher than those on new vehicles and will vary depending on the applicant's credit card, loan term, and more. That said, on average, you can anticipate paying 8% interest on a car loan that has a 4 to 5-year loan term.

Can you negotiate your APR on a loan?

Whether or not you'll be able to negotiate your car loan rates will really depend on who you're borrowing from, your creditworthiness, and the amount you're borrowing. That being said, negotiating regardless is recommended, given that lenders are necessarily required to offer you the best deal available upfront.

Is getting a car loan possible if I have bad credit and no co-signer?

Getting a car loan with bad credit and no co-signer, is it possible? The short answer is yes, you can be approved for a car loan with a poor credit score. However, there are some things you'll need to be aware of before considering this option. Because your credit score is lower, you may have to settle for a higher interest rate than normal. With this, you'll also have to make higher monthly payments, which may not make sense given your current financial situation.

Another thing to keep an eye out for is the repayment term. While some auto loan lenders will approve loans to people with bad credit, they often do so with longer repayment terms, which means you'll be paying more interest over time, making your vehicle purchase more expensive altogether. If you can, make sure to compare interest rates and lenders before signing your loan agreement to ensure you're getting the best deal available.

Will I be penalized for paying off my outstanding balance before the end of my loan term?

Whether or not you'll be charged a prepayment fee will depend on the terms and conditions listed in your loan agreement. We recommend reading your loan contract for more information or giving your lender a call directly for clarification.

Is a 746 credit score good or bad?

"Is a 746 credit score good or bad?" might be on your mind if you've recently conducted a soft credit check on your finances. We're happy to say that according to TransUnion, the average credit score in Canada is roughly 680. And because yours is over that, you can rest assured that a 746 credit score is fantastic.

If you want to increase your score even more, continue making your monthly payments on time, diversifying your credit mix, and keeping your debt-to-income ratio as low as possible!

What credit score is needed for a car loan?

Now that you know what a good credit score is classified as, what credit score is needed for a car loan? The truth is the minimum credit score required for a car loan will vary between lenders. That said, on average, you'll need at least a 600 - 650 credit score to be approved.

If you're shopping around and comparing interest rates, you may find that online lenders don't require as many prerequisites to be approved. Just keep in mind that these types of lenders tend to have shorter repayment terms, which will increase your monthly payments, hidden fees, and higher interest rates.

Why is a good credit score important when applying for an auto loan?

The importance of a good credit score for financing a car is similar to taking out any type of personal loan. This score essentially shows lenders how risky it is for you to borrow money from them. The lower your credit score, the more of a risk you'll be, given that it indicates that you are unable to handle funds responsibly.

In contrast, having excellent credit can help you save money when you make a car purchase by offering you a lower interest rate, which will lower your monthly auto loan payments. Additionally, it will also give you more leeway when it comes to financing options and your loan term.

Unsure what your current credit score is? Get a free credit score check with KOHO!

What a bad credit score means

So, you've got a bad credit score. What does it mean? As we mentioned, having a low credit score indicates that you're more of a risk when borrowing money. Think of it like a report card. But, instead of testing how well you know history and science, it's testing how well you're able to handle your finances.

It's important to know that while a lower credit score can make it more difficult for you to get a personal loan for your car, it's not permanent. By paying off your monthly payments on time, diversifying your credit mix, and keeping your debt-to-income ratio, you can slowly improve your score over time.

What affects your credit scores

So, what affects a credit score? Your credit information is sent to one of the three credit bureaus in Canada. With this information, the bureaus create a detailed credit history that is composed of numerous factors. Credit bureaus are pretty tight-lipped when it comes to how they calculate scores. However, what we know for sure is that the following factors are used when calculating your credit score:

• The capability of making payments on time each month.

• The length of your credit history.

• Your ratio of debt to income use.

• How much of your available credit you spend each month.

• The different types of credit in your credit mix.

• Other factors.

How to build credit with a secured credit card?

Developing a good credit history and building credit throughout your life will benefit you later on if you need to borrow money for costly purchases like a new car or house. If you've thought about taking on additional debt, you might be curious about how to build credit with a secured credit card.

The requirement for an initial security deposit on the card is what differentiates secured credit cards from others. Your credit limit is the amount you put down, and you are not allowed to spend more than it. This kind of card could benefit you if you have poor spending habits and bad credit; however, by putting small purchases on your card and continuing to make your payments on time, you can build your credit over time.

Build your credit with KOHO

At KOHO, we help Canadians streamline their plans for spending and saving every day with several financial products customized to meet their unique needs.

Whether you want to build your credit with KOHO by opening a virtual credit card with overdraft protection coverage, get a cash advance for emergency purchases, or enjoy high-interest savings to make a return on the money you deposit, you can do it all with the help of KOHO!