How to Calculate Effective Annual Interest Rate on a Car Loan

Budgeting for car payments is an important part of a comprehensive cash-flow plan and money-management strategy. Knowing the amount of the car loan and the annual interest rate will help you calculate what your monthly payments for the car will be and how long it will take you to pay it off. However, if the interest on the car loan is compounded more than yearly, the amount of your car loan plus interest may be more than you think. An annual interest rate when the interest is compounded more than annually is known as the effective annual interest rate. Determining the effective annual interest rate will enable you to calculate the exact amount you will pay on the loan.

Instructions

1

Determine the initial amount of the car loan and the given annual interest rate for this loan. Also verify how often the interest is compounded (generally it's monthly). For the purpose of this example, let us designate the annual interest rate as 10 percent.

2

Divide the annual interest rate by 12, or however often the interest is compounded in a yearly period. Add 1 to this number. An annual interest rate of 10 percent compounded monthly would yield 0.1/12 + 1 or 1.008333.

3

Raise the result from Step 2 to the power of 12, or however often the interest is compounded annually. The numbers from our example give 1.008333^12 = 1.1047.

4

Subtract one from the number determined in Step 3. This is the effective annual interest rate for the car loan. For our example, the effective annual interest rate is 1.1047-1= 0.1047, or an effective annual interest rate of 10.47 percent. Use this number to determine how the effective annual interest rate will affect the amount of the loan in a year's time.