FinanceUpdated May 18, 2026🕐 5 min read
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How Car Loans Work
A car loan is a secured amortising loan where the vehicle itself acts as collateral. Each monthly payment covers both interest on the outstanding balance and a portion of the principal. In the early months, more of each payment goes toward interest. Understanding how the payment is calculated, how interest front-loads, and how to compare total cost across different offers prevents paying significantly more than necessary.
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Quick reference
Typical car loan APR
5 to 12%
Depends on credit score and loan term
Standard terms
36, 48, 60, 72 months
Longer term = lower payment but more interest
Front-loading
Month 1 is mostly interest
Principal portion grows each month
Total interest rule
Longer term costs more
60 months at 7% costs 40% more interest than 36 months
How car loan payments are calculated
A car loan uses the standard amortization formula to calculate a fixed monthly payment that fully repays the loan over the chosen term. Every payment is identical in amount but its composition changes each month. In month one, the majority of the payment covers interest on the full outstanding balance. As the balance reduces, less interest accrues each month and more of each payment goes toward principal reduction.
This front-loading of interest is why paying off a car loan early saves more than you might expect. In the first half of a 60-month loan at 7% APR, you pay roughly 60% of the total interest despite only being halfway through the term.
The three inputs that determine your monthly payment are: the loan amount (the car price minus any deposit), the annual interest rate converted to a monthly rate, and the loan term in months. A larger deposit reduces the loan amount and therefore the payment and total interest. A shorter term increases the monthly payment but reduces total interest paid significantly.
Dealer finance and bank loans use the same formula but differ in the rate offered. Dealers often mark up the rate above what the lender charges — a practice called dealer reserve — which increases your total cost. Always obtain a bank or credit union quote before accepting dealer finance.
The car loan payment formula
Formula
M = P \times \frac{r(1+r)^n}{(1+r)^n - 1}
The monthly payment equals the loan amount multiplied by the monthly interest rate times the compound growth factor, divided by the compound growth factor minus one. This produces a fixed payment that covers both interest and principal reduction every month for the full term.
MFixed monthly payment
PPrincipal — the amount borrowed after deposit
rMonthly interest rate — annual APR divided by 12
nTotal number of monthly payments — years multiplied by 12
How interest front-loads across the loan term
In month one of a 20.000 car loan at 7% APR over 60 months, the monthly payment is 396. Of that 396, the interest portion is 20.000 x (7% / 12) = 117. The principal portion is 396 - 117 = 279. The new balance after month one is 20.000 - 279 = 19.721.
In month two, interest is charged on the reduced balance: 19.721 x (7% / 12) = 115. The principal portion grows to 281. This pattern continues throughout the term — interest shrinks, principal portion grows.
By month 30 (the halfway point), the monthly interest charge has fallen to approximately 79 and the principal portion has grown to 317. By month 55 of 60, the interest charge is just 14 and nearly the entire payment goes toward the final balance.
This pattern means that if you sell or refinance the car in the first two years, you have paid a disproportionate amount of interest and paid off very little principal. The loan balance will be much closer to the original amount than you might expect.
Result: 36 months: 618 per month, 2.248 total interest | 60 months: 396 per month, 3.760 total interest
36-month payment: 20.000 x (0,005833 x 1,2330) / (1,2330 - 1) = 618. Total: 618 x 36 = 22.248. Interest: 2.248. The 60-month term saves 222 per month but costs 1.512 more in total interest over the life of the loan. The longer term is 67% more expensive in interest terms.
Example 3Impact of deposit on total cost
Given: Car price: 22.000 | APR: 7% | Term: 60 months | Compare 0 deposit vs 4.000 deposit
Result: No deposit: 436 per month, 4.136 total interest | 4.000 deposit: 357 per month, 3.420 total interest
No deposit: loan = 22.000, payment = 22.000 x 0,01980 = 436, total interest = 4.136. With 4.000 deposit: loan = 18.000, payment = 18.000 x 0,01980 = 357, total interest = 3.420. The 4.000 deposit saves 79 per month and 716 in total interest. Every euro of deposit directly reduces the interest-bearing balance.
Car Loan Calculator
Enter the car price, deposit, APR and term to see your monthly payment, total interest and full amortization schedule.
Monthly payment and total interest by term — 20.000 loan at 7% APR
Term
Monthly Payment
Total Paid
Total Interest
Interest as % of Loan
24 months
896
21.504
1.504
7,5%
36 months
618
22.248
2.248
11,2%
48 months
479
22.992
2.992
15,0%
60 months
396
23.760
3.760
18,8%
72 months
341
24.552
4.552
22,8%
Common mistakes that increase the total cost
✗ Focusing on the monthly payment rather than the total cost
✓ A longer term reduces the monthly payment but increases total interest paid significantly. Always calculate total interest across the full term, not just whether the monthly payment fits the budget. A 72-month loan on a depreciating asset like a car often means owing more than the car is worth for the first two to three years.
✗ Accepting dealer finance without comparing alternatives
✓ Dealer finance is convenient but often carries a marked-up rate above what the lender charges. Obtain a pre-approved quote from your bank or a credit union before visiting the dealer. You can then use the bank quote as leverage to negotiate the dealer rate, or simply use the bank loan if it is cheaper.
✗ Not accounting for depreciation against the loan balance
✓ A new car loses 15 to 25% of its value in the first year. On a 20.000 car with a 60-month loan and no deposit, the loan balance after 12 months is approximately 16.700. The car may be worth only 15.000 to 16.000. If the car is written off or you need to sell, you may owe more than you receive — this is called negative equity.
✗ Refinancing without calculating whether it saves money
✓ Refinancing a car loan to a lower rate saves money only if the interest saving over the remaining term exceeds any refinancing fees. Because interest front-loads in the early months, refinancing in the final third of a loan term saves very little — most of the interest has already been paid.
Methodology
All payment calculations use the standard amortization formula with monthly compounding. Monthly rate equals annual APR divided by 12. Total interest equals total payments minus principal. The amortization schedule allocates each payment first to interest on the outstanding balance, then to principal reduction.
Calculations assume a fixed interest rate for the full term. Variable rate car loans will produce different results if the rate changes during the term.
What credit score do I need for a good car loan rate?
Lenders typically offer their best rates to borrowers with credit scores above 720. At this level you can expect rates in the 5 to 7% range for a new car. Scores between 660 and 720 typically attract rates of 7 to 10%. Below 620, rates can exceed 15% and some lenders will decline the application entirely. Improving your credit score before applying — by reducing credit card utilisation and ensuring no missed payments — can save thousands over a 60-month loan.
Should I put a deposit down on a car loan?
Yes, a deposit reduces the loan amount, the monthly payment and the total interest paid. More importantly, it reduces the risk of negative equity — owing more than the car is worth. On a new car that depreciates 20% in year one, a 10% deposit means the loan balance tracks closely with the car's value. Without a deposit, you are likely in negative equity for the first 18 to 24 months of a 60-month loan.
Can I pay off a car loan early?
Yes, and it saves money because you stop paying interest on the remaining balance immediately. Check whether your loan has an early repayment charge — some fixed-rate car loans impose a fee of one to two months' interest for early settlement. If there is no penalty, any overpayment reduces the principal directly and shortens the term. Paying an extra 100 per month on a 20.000 loan at 7% over 60 months reduces the term by approximately 11 months and saves approximately 650 in interest.
What is the difference between a hire purchase and a personal loan for a car?
With a hire purchase (HP) agreement, the lender owns the car until the final payment is made. You cannot sell the car without the lender's permission during the term. With a personal loan, you own the car immediately and can sell it at any time. HP agreements are secured against the vehicle, so the rate is often lower than an unsecured personal loan. However, the lender can repossess the car if you miss payments, which is not the case with an unsecured personal loan.