A lower monthly auto loan payment doesn't always mean you're saving money. This is how car loans work.


Buying a car usually means applying for a car loan. If you're looking for a new car, you've probably spent a lot of time researching car options, but do you have a good understanding of how car loans work? When you get a car loan from a financial institution, you receive your money in one lump sum and pay it back (plus interest) over time. How much you borrow, how long it takes you to pay it off, and your interest rate all affect your monthly payment. Here are 3 main factors that affect your monthly payment and the total loan you will pay:

loan amount. It can be significantly less than the car's value, depending on whether you have a trade-in vehicle and/or paid a deposit.

annual interest rate. Commonly called the APR, this is the actual interest rate you pay on the loan. loan term. This is how long you have to repay the loan, usually 36-72 months. How do these 3 factors affect your monthly payment?

Lower monthly payments always sound good, but it's important to look at the bigger financial picture: Lower payments could also mean paying more for your car over the life of the loan. Let's see how adjusting these three factors can affect your monthly payment:

Lower loan amount. Let's say you're considering a $25,000 car loan, but you put down a $2,000 down payment or negotiate a $2,000 reduction in the price of the car. Your loan amount is $23,000, saving you $44.27 per month (3.00% APR for 4 years).

Lower APRs. Consider the same $25,000 car loan, assuming a 4-year term. One financial institution offers 3.00% APR and another 2.00% APR. If you choose the lower APR, you can save $10.98 per month.

Longer credit period. Extending the $25,000 loan from 4 years to 5 years (assuming an APR of 3.00%) would reduce your monthly payment by $104.14, but you end up paying $391.85 in interest costs over the life of the loan. Use the Bank of America Auto Loan Calculator to tweak the numbers and see how differences in loan size, APR and loan term can affect your monthly payment.

How lower monthly payments can cost you more One of the most important things to understand about how an auto loan works is the relationship between the term of the loan and the interest you pay. A longer loan term can significantly lower your monthly payment, but it also means you pay more in interest.
Consider a $25,000 car loan at 3.00% APR for 48 months. Over the 4 years, you will pay a total of $1,561 in interest on the loan. If you extended the same loan to 60 months (or 5 years), your monthly payment would be reduced by $104 -- but the total interest you paid would increase from $1,561 to $1,953. Weigh all factors before you decide There is no one-size-fits-all approach to finding the best car loan. That's why you need to take the time to understand how auto loans work and make the right decision based on your specific financial situation. Some people will benefit most if they extend the term to reduce their monthly payments and use the difference to pay off high-interest debt. Others prefer to pay higher monthly payments and pay off the loan as quickly as possible. If you have an existing car loan, you can save money by refinancing it. Try our refinancing calculator to see if refinancing can lower your monthly payment. Ready to start? Compare Bank of America auto loan rates today.

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