If you plan on financing a new or used vehicle, understanding how auto loan interest works can help you make the smartest borrowing decision for your finances. While it’s natural to focus on the monthly payment, the real cost of borrowing money for an auto loan comes down to the interest rate.

What Determines Your Auto Loan Interest Rate?

Your credit score, loan term, and down payment are the biggest factors that determine an auto loan interest rate. A higher credit score typically earns a lower rate because lenders see you as less risky. If you have challenges with your credit though, you’ll likely pay a higher interest rate, which makes borrowing more expensive.

The length of the loan, or the loan term, should also be considered. Shorter loan terms often come with better rates, while longer terms mean you’re paying more in total interest over time.

A larger down payment naturally reduces the amount you’re borrowing, which means you’ll pay less in interest costs over time, compared to financing a larger amount. 

Simple vs. Compound Interest

Most auto loans use simple interest. This means you pay interest only on your remaining balance and not on the interest you’ve already accrued. This can incentivize the borrower, since the faster you pay down your loan, the less you’ll pay in total interest.

If a loan uses compound interest, then you’re charged interest not only on the original amount you borrowed but also on any interest that’s already been added.

Some lenders may calculate interest differently, so it’s always smart to ask how your loan is structured before signing.

Why APR Matters

An Annual Percentage Rate (APR) includes both your interest rate and any loan fees. Comparing APRs and not just the interest rate gives you a clearer picture of what your loan actually costs. Even a one-point difference in APR can add hundreds or thousands of dollars over the life of your auto loan.

It’s possible you can save on auto loan interest by shopping around and comparing lenders, plus improving your credit score as much as possible before financing. Understanding how auto loan interest works helps you borrow wisely and save more in the long run, so you can have peace of mind long after you drive off the lot.

More Questions?

Contact our lending team at Eureka Savings Bank! We can help you understand which auto loan options will work best for your personal financial situation.