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Tips to calculate the cost of a car loan

If you’re in the market for a new or used vehicle, you’re probably thinking of all the ways you might go about securing the funds to pay for that new ride. Vehicles are big purchases! Dealerships, private lenders and banks will offer those without a huge stash of cash a wealth of financing options. Financing helps people cover the upfront costs of a new vehicle purchase through an auto loan.

Today, we’ll look at a range of factors that go on to calculate the cost of your car loan. There are definitely ways you can make yourself more loanworthy in the eyes of a lender, helping you get fair interest rates and fair loan terms while minimizing the overall cost of your loan. 

Total vehicle cost

The overarching factor that will determine the cost of your car loan is the price of the vehicle you have your eye on. Depending on the price of the new wheels, the taxes on that price, and the down payment, you’ll start to get an understanding of how much you need to borrow from your lender to start negotiations. Some vehicles are cheaper to finance and insure than others. 

Down payment

Next, you should be thinking about how or what you can contribute to the car purchase so that you can cut down the amount of money you’re borrowing.

Can you trade in your old, used vehicle to help reduce the amount of money you need? If you’ve saved up a chunk of money already, putting it towards your new vehicle will act as a down payment that goes on to minimize the loan.

If you have the ability to start saving in advance you’ll incur less debt overall. Down payments also make you look great to your lender; it means you’ve taken some time to think ahead and save money. Showing financial responsibility with a decent down payment makes you less risky to the lender, opening up better interest rates.

Loan term

If you sign up for a longer loan term, you’ll pay less per month at a lower interest rate, or so it appears. The longer you take to repay your loan, the longer you’re paying your lender interest, even if that interest rate is lower than a shorter term.

If that sounds confusing, it doesn’t have to be. Car loans tend to last between 36 and 72 months, or three to six years. If you need to pay back the loan for 48 months or more, you might want to consider a vehicle that’s more affordable. You’ll want to steer clear of any car loan terms that last longer than 48 months.    

Interest rate

Also known as the loan rate, the interest rate represents the profit the lender stands to make by helping you out with a loan.

Interest rates can be simple or compound, so always read the fine print. Simple interest rates will not change during the lifetime of the loan, whereas the total paid through compound interest is harder to predict until you get to the end of your term.

With a simple rate, you’ll be paying an additional percentage of the amount loaned on each monthly payment. With a compound rate, you’ll be paying back the principal amount, plus the interest that accumulates on that initial amount each pay period. If your debt becomes bigger, the amount of interest you pay will also increase, so it’s important to meet your payment deadlines every time if you’re dealing with compound interest.

Your credit always matters with a loan

If you have some decent credit and steady employment with verifiable income, chances are you’ll get a fair interest rate that allows you to repay your loan without much stress.

Lenders will look at your credit report to determine how worthy you are of the loan. They’ll be paying attention to the amount of money you’ve borrowed in the past, how much debt you're carrying at the moment and if you pay your bills on time

Debt to credit ratio

The lender wants to ensure their loan will be repaid, preferably on time. To gauge how likely you are to pay the loan back on time, they’ll look at your debt to credit ratio. Lenders will want to know how much you currently owe others and compare that number to how much you make per month.

If you owe more than you’re bringing in, giving you a loan may seem like a big risk – liable to affect how much cash you qualify for and at what interest rate.

If you’re making much more than you owe, your lender can assume you’ll pay the loan back properly, making you less of a risk. Less risk means better loan terms, of course!

Look into how much you owe to other lenders like bank lenders, private creditors or government lenders. Remember, there are good and bad types of debt.