Car Payment Quick Facts
- Your car payment is the monthly amount you owe to pay back an auto loan.
- Car payments include the principal or the original loan amount, the interest or what the lender charges you to borrow money, and other fees.
- Higher interest rates mean higher monthly car payments.
- A “down payment” reduces the amount you need to finance, which can make a smaller car payment.
When most consumers calculate car payment amounts, they consider the whole number, but what about the breakdown? Car payments are made up of several parts, and while all lenders have their specific formula to determine eligibility, each piece of the payment pie is largely the same. Read on to understand the basics of vehicle payments.
Down Payments
A down payment is the amount of money you pay upfront to cover a portion of the vehicle’s total purchase price. Placing a down payment only applies when you finance a car via a loan or lease. For example, you might put $5,000 “down” when financing a $30,000 automobile. The remaining $25,000 balance is spread evenly over 24 to 60 months or longer, depending on the terms of your contract.
While there is no universal amount or percentage for a down payment, lenders may have requirements, and general rules of thumb exist. Amounts will vary depending on a few factors, including:
- Vehicle purchase price
- Your credit history
- Your credit scores
- How soon you’d like to pay off the loan
Consumer credit reporting agency Experian recommends putting at least 20% down to help safeguard against any immediate vehicle depreciation. That way, you don’t owe more than the vehicle is worth as soon as you drive off the lot. Additionally, a higher down payment can help lower your monthly car note. The more you put down, the less you owe, which means there’s a smaller amount to finance.
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Principal
A conventional car loan has two main parts — the first is the principal. The Consumer Financial Protection Bureau defines the principal as the amount of money you originally agreed to repay. This sum is determined by the cost of the vehicle plus any dealer add-ons, like delivery fees, an extended warranty, or gap insurance coverage.
Essentially, the principal is your bottom line. Using the same finance example above, if you purchase a car for $30,000 and put $5,000 down, the remaining $25,000 is the principal. The lender might include dealer fees and add-on services in the principal if those costs are part of the vehicle’s “out-the-door” price.
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Interest
The other main component of any car loan is the interest. The term “interest” refers to the fee your lender charges to cover the cost of the principal. Charging interest on the money it loans is how the lender makes money. The bank, credit union, or other lender calculates the interest using a percentage rate called “APR” or annual percentage rate.
Your costs may include the interest plus additional charges like loan origination and borrower fees.
Factors that Affect Your Interest Rate
The lower your interest or APR, the lower your monthly payments. Here are some factors that affect your rate:
- The lender – Some financial institutions offer lower rates than others. If you’re shopping for a new or used car, also shop around to find the best interest rate. Credit unions often have better interest rates compared to large banks.
- New vs. used vehicles – Interest rates for new vehicles are usually lower than those for used cars.
- Credit scores – Different lenders work with different credit reporting bureaus, so your credit scores from Experian, Equifax, and TransUnion may all be under consideration. Those companies have unique formulas for calculating risk, so your score may vary between the bureaus.
- Credit history – Your credit score is a significant component. Lenders may scrutinize your payment history, specifically with previous car loans. Lenders offer higher rates if you’ve made late payments or defaulted on an auto loan in the past.
- The length of the loan – Loans with longer terms usually have higher interest rates; shorter payoff periods come with lower interest rates.
- The state of the economy – When the economy is good, many lenders lower interest rates to entice borrowers. But a booming economy can bring too much of a good thing. So, the U.S. Federal Reserve may raise interest rates to help slow things down and keep growth in check. The Fed’s increased prime rate impacts lenders’ rates, which makes monthly auto loan payments higher.
Additional Amounts
If you’re trying to pay the loan ahead of schedule, you can make extra payments to the principal. You can make these payments after you’ve settled the interest costs for the current billing cycle. Some loans have an early payoff penalty, so read your contract’s fine print and see if there are fines for paying sooner than the maturity date.
Late fees may be added to your next car payment if you miss your loan installment due date. These fees do not apply toward the principal or the interest, and the amount will vary by lender.
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Car Lease Payments
The terms of your car lease payments will differ from those outlined in a conventional finance deal. Instead of paying off the loan, you’ll pay an established amount each month that covers the estimated depreciation over the life of the lease. The interest costs are also wrapped into this closed-end contract. See our comprehensive car leasing guide to learn more.
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