A Complete Breakdown of How Auto Loans Are Structured
A recent study by Experian, one of the three main credit companies in the U.S., reveals that automotive debt grew to record high in the past two years, despite the recent pandemic that swept the globe. In 2020, the total consumer auto loan value was at a staggering $1.37 trillion. With this much money being forked for auto loans, it behooves consumers to understand how auto loans are structured.
One of the key data points used to calculate your auto loan is, of course, your vehicle price or the amount you need to borrow to buy a specific make, model, and condition, i.e. used or brand new. If you are planning to put money down or trade in an existing vehicle, simply deduct that value from the vehicle price to get the loan amount.
Repayment term pertains to the lifespan of the loan contract. For auto loans, it is usually anywhere between two and six years. As a general rule of thumb, the longer the loan’s repayment term is, the more money you end up paying in interest. Ideally, you’ll want to sign up for the shortest term that your monthly budget allows for.
Another important variable used by all auto loan calculators is interest rate, or the total cost to borrow cash from your auto dealership or bank. The number is typically expressed as a percentage. The average interest rate for new vehicles is four percent while used car loans are tacked on with an average of eight percent interest. Monthly interest is computed by dividing the interest rate percentage by the repayment term and then multiplying it with the total loan amount.
Example of Auto Loan Calculation
Let’s say you are planning to borrow $30,000 from your bank. They quote you with a six percent interest rate over a 12-month period. This sums up to a monthly interest payment of $150 or $1,800 in a year. A longer repayment term, say 36 months, at the same interest rate percentage can bring that yearly interest payment up to $2,856.
Factors Affecting Interest Rate
Apart from loan amount and repayment term, your auto loan’s interest rate can significantly change based on personal factors. These include your credit score, annual income, and existing debt. Of the three mentioned, credit score may be the biggest factor that decides the interest rate you are pre-approved with. It’s best to improve your credit score before applying for an auto loan from your bank and before visiting your auto dealership.
With 85% of new cars financed in the U.S., auto loans are unarguably one of the most popular consumer financial products there is today. Make sure you get a fair auto loan quote from lenders by understanding how exactly the product is structured by these institutions.