You’re ready to buy a car. Whether it’s a new car or a used car, unless you’re planning to pay for the car upfront, you’ll probably need an auto loan.
You can get an auto loan from the dealership or from a bank, but when you take out an auto loan, you’re committing to an auto loan payment. That’s money that you’ll need to pay every month on time, and without fail, until you’ve paid off your loan.
But as you’re considering which car to buy, you may be wondering:
- How much can you really afford to spend on a car?
- How much will your auto loan payment be?
- Will the payments fit into your current budget?
Don’t worry. This helpful guide will make it easier for you to figure out how much your auto loan payment will be and how to use it to decide how much car you can afford.
Information Needed To Calculate an Auto Loan Payment
Before you can determine your auto loan payment, it’s helpful to understand that the actual cost of owning a car isn’t the same as the sticker price.
To calculate how much your auto loan payment will be, you’ll need to know the following:
The cost of the car
The final price of your car will be determined by the following factors:
- Purchase price: This is the starting price that you agree to pay for the car. It may be the same as the sticker price or if you’re a savvy negotiator, you may be able to convince the dealer to lower the price for you.
- Sales tax: Every state and locality (usually a city or county) has its own auto sales tax rate. While some states and localities charge 0% in taxes, others can charge over 8%. Whatever the sales tax rate, you’ll need to add both of those together and add that amount to the purchase price when considering the cost of your car.
- Fees: Most dealerships will charge you fees for various services related to the sale of the car. Some fees like title and registration fees are required by the state when purchasing the car. Others, like the documentation fee (the money they charge to do the paperwork) or destination fee (the money they charge to bring the car to the dealership), are charged at the discretion of the dealer and may be negotiable.
- Down payment: Of course, you don’t have to finance the total cost of the car. Putting money down not only lowers the cost of buying your car, but it may also improve your chances of getting better terms on your auto loan.
- Trade-in: If you currently own a car, you can offer to trade it in at the dealership in exchange for a lower price on the car. This can be convenient, but you may make more money by selling the car before you go to the dealership. If you still owe money on the car you plan to trade-in at a dealer, the dealership will payoff the loan.
The total value of your trade-in will be deducted from the cost of the vehicle you plan to buy, lowering the sales tax you’ll pay. Otherwise, if you sell your vehicle privately, you must first payoff the loan.
When you take out an auto loan, you’ll need to consider two key factors that define the terms of your loan:
Length of your loan term
Auto loan terms are usually broken down into 12-month blocks, so you’re usually offered loan terms of 24-months, 36-months, 48-months or 60-months. The longer the loan term, the less you’ll pay each month, but you’ll pay more in interest over the life of the loan.
This is the amount of interest that your lender is charging you to borrow money from them. Your interest rate will be based on a number of factors including your credit score and credit history as well as the amount you’re able to put down toward the purchase price of the car.
Calculating a Car Payment
Once you have all of this information it’s time to calculate the size of your car payment. The basic formula goes something like this:
- Take the purchase price of the car and deduct your down payment or the trade-in value of your old car.
- Add the taxes and fees to your current total.
- Divide by the total number of months in the loan term.
- Calculate the amount of interest you’ll need to pay each month and add it to your monthly total.
Here’s an example:
- You want to buy a $25,000 car.
- Your dealer offers you $2,000 for your old car and you’re able to put $3,000 down.
- Your current purchase price is now $20,000.
- Now let’s say that your total sales taxes are 4% ($800) and your dealer charges an additional $500 for registration and inspection fees for a new total of $21,300.
Assuming that you roll your taxes and fees into your total loan amount, you would then divide the $21,300 by the number of months in your loan term.
|Number of months
|Monthly payment before interest
That covers the principal, but what about the interest?
Calculating a Car Loan’s Monthly Interest
You can calculate your exact interest payment using a simple interest calculator or an auto loan calculator. The calculator will usually show you how much you’ll pay toward the interest and principal each month that you have your auto loan. With auto loans, you’ll pay the most toward interest in the first month and the least toward interest in the last month.
How can that help you if you don’t have an auto loan calculator handy? Well, there’s a simple interest formula for calculating the monthly interest rate on your auto loan.
Monthly interest = (Annual interest rate / 12) x loan balance.
For our $21,300 car at 4% annual interest. That would be:
(.04 / 12) x $21,300 = $71
But as we mentioned, every month that you make a payment, your balance goes down, so you won’t pay $71 in interest every month.
If you think about it, you’ll pay the full amount of interest ($71) the first month and close to $0 the last month. So if you want to do a quick calculation, you can take your monthly interest and calculate the average by adding $71 and $0 and dividing by 2, for a monthly interest payment of $35.50.
Then simply add the $35.50 to your pre-interest monthly payment. When you compare that to the actual monthly payment (determined using an auto loan calculator) here’s what you get.
|Number of months
|Monthly payment + $35.50 interest
|Actual monthly payment
The numbers will get further apart as the car gets more expensive and the interest rate gets higher, but for a back-of-the-envelope calculation, it works.
How To Determine What You Can Afford
So how much car can you afford? Owning a car has two different types of costs. The cost to purchase and the cost of maintenance and ownership.
Let’s assume that you do the math and decide that you can afford that $21,300 car with a monthly payment of $392.27 a month for 60-months.
But before you consider the matter settled and sign the paperwork, don’t forget that your car has other costs.
Unless it’s an electric vehicle, you’ll need to take your car to the gas pump to keep it moving. A newer car may cost more but get better gas mileage, which can cost more upfront, but save you money at the pump. Or if you buy a classic car, you may need to put in a more expensive grade of gasoline to keep it running.
Of course, the amount you’ll pay for gas each month can vary wildly depending on where you live, the distances you drive each month and the current world situation.
Maintenance and repairs
Over the course of a year, your car will probably require regular maintenance like oil changes, tire replacement, battery replacement and more. That’s assuming you don’t get into an accident, or your car breaks down.
Keep in mind, the older your car, the more likely it is to need to be repaired, so while an older car may cost less, it may have higher maintenance costs while you own it.
Most states require that you have a minimum level of insurance on your car. If you’re a good driver with no accidents on your record, that can cost around $1,300 a year or $108 a month. The more expensive or unique your car, the more it will cost to insure.
When you add the total amount of these extra expenses to your monthly auto budget, you may find that your car costs you much more than you originally anticipated.
The Extra Math Will Pay Off Later
When you see the car of your dreams, you probably don’t think too much about the monthly cost. But you should. Doing the extra math to calculate your monthly auto loan payment can help ensure you can really afford the car of your dreams.
The Short Version
- To calculate your auto loan payment take the purchase price, subtract your down payment and the value of your trade-in. Add taxes, fees and interest then divide by the loan term
- Your interest is based on your loan balance, so every month that you make a payment, your balance goes down, so you pay less in interest and more toward the principal
- Auto loan terms are usually broken down into 12-month blocks, so you’re usually offered loan terms of 24-months, 36-months, 48-months or 60-months
U.S. News and World Report. “Average Cost of Car Insurance in the US for 2022.” Retrieved May 2022 from https://www.usnews.com/insurance/auto/average-cost-of-car-insurance