How Does Auto Loan Interest Work?

Auto loan interest is calculated using a simple interest formula.

Auto loan interest is usually calculated using a simple interest formula, as opposed to a compound interest formula. This means that your monthly payments include principal and interest paid only on the principal (and not on incurred interest balance).

Basics

Common auto loans are established for 36- to 72-month payoff terms. Similar to home mortgages, auto loans are paid on an amortized schedule that takes into account the principal, interest rate and loan period.

Formula

Your total interest paid over your loan term is calculated by multiplying the original principal balance by the interest rate and multiplying that total by the loan term in years.

Function

Your initial loan payment has the highest proportion of interest to total payment ratio. Each month's payment has a portion applied to the principal balance, which reduces your principal. This means the next month's interest will be calculated on a lower balance. By paying additional principal as possible, you can pay less total interest over the loan term.

References

• Vertex 42: Simple Interest Formula and Calculator
• Rice University, Barbara Christopher: Calculating a Car Payment