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Published On: Tue, Mar 3rd, 2020

How to Calculate a Car Loan Payment

The two largest-ticket items most people will ever purchase are a car and a home. Further, some form of financing will be required to make either of those purchases happen in most cases.

This makes it extremely important to understand how loans work and, more critically, how what you’ll be asked to repay is computed. This is particularly true in the case of an automobile, as it’s easy for a seller to make an unfavorable deal look palatable if you don’t know how to calculate a car loan payment.  

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The Key Elements of an Auto Loan

The primary factors are the purchase price of the vehicle, the amount of your down payment, the term (or length) of the loan and the interest rate applied to the loan. Far too many people go shopping for a car with their attention fixed upon the monthly payment they’ll make. While we do agree this is a relevant concern, anyone adept with numbers can make a monthly car payment look great while charging more than they should for the vehicle. 

Purchase Price

 If you’ve ever shopped for a new car, you’ve no doubt seen the window sticker listing the Manufacturer’s Suggested Retail Price or MSRP. In most cases, this number is merely the starting point for the negotiations process. As the nomenclature indicates, this is the suggested price at which the car should be offered. The actual price can be significantly lower once dealer incentives and negotiations are factored into the equation. How much less varies, depending upon the market demand for the car, but few cars sell at MSRP. The price at which the transaction is actually conducted is the purchase price. 

Down Payment

Once you’ve settled on an acceptable price for the car, you’ll offer a down payment to secure the loan. This is typically 20 percent of the purchase price — which the lender looks upon as assurance you will follow through and make your payments. Basically, the down payment is your “skin in the game” so the lender isn’t taking all of the risk. After all, you’ll lose both the car and the money you offered as a down payment if you default on the loan. A down payment can also be in the form of a car you’re trading in. 

Loan Term

The number of months over which you spread the loan payments is known as the term of the loan. The average these days is 60 months (five years). Shorter terms are available, but the monthly payment — as you may have already surmised — will be higher. With the average transaction price of a new car hovering in the middle $30,000 range these days, most people are opting for five-year loans to make the payment more affordable. 

Terms of up to 84 months are available, however, most experts advise consumers to avoid them because the actual cash value of a car typically becomes less than the outstanding loan amount when terms exceed 60 months. In other words, you’ll owe more than the car is worth. Moreover, the longer the term, the more you’ll pay in interest, which means the purchase price will be higher.

Percentage Rate

The final factor is the rate of interest you’ll be asked to pay to secure your car loan. The primary determinant here will be your credit score. Buyers with higher credit scores are perceived to be less of a risk and consequently are offered lower interest rates. As an example, according to U.S. News & World Report, buyers with a credit score of 750 or better can expect new car rates of about 4.98 percent as of February 2020. Meanwhile, buyers with a credit score of 449 or less will be looking at 18 percent interest. 

How It All Fits Together

Now you know what goes into calculating a car loan payment. Let’s say you negotiate a purchase price of $36,000, against which you make a down payment of $7,200. You settle upon a loan term of 60 months and you qualify for an interest rate of 4.98 percent interest. 

Plugging those numbers into an auto loan calculator, you’ll get a monthly payment of $543.33, for a total purchase price of $39,793.80. However, if you stretch that loan out to 84 months, you’d pay $406.79 a month for a total of $41,370.36 for the same car. If your interest rate were 18 percent, the monthly payment would be $731.33 for a total purchase price of $51,079.80 over 60 months. An 84-month term would find you paying $605.31 a month, which would add up to $58,046.04.

Thus, you can see how even though the monthly payments are lower, you can wind up paying a lot more for the car overall. This is why you should always negotiate a car deal based upon the purchase price rather than the monthly payment.

Author: Amara Etter

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