On a $20,000 car loan at 7 percent, the total interest paid is almost $3,800. The way car loan interest is calculated means the interest amount is different on each payment and for each year of the loan. If you understand how loan interest works, you can determine what portion of that $3,800 is paid to the car cost each year.
Loan Interest Function
Car loan interest is calculated on the amount of the outstanding loan balance. The interest rate is computed for a monthly rate by dividing the annual rate by 12 and that rate is applied to the loan balance to determine the interest amount on the next payment. The amount of the car payment not attributed to interest is the amount that goes to reduce the loan balance. The interest due always controls how a payment is divided between principal and interest.
Calculate A Payment Distribution
On a $20,000 car loan at 7 percent for a five-year term, the monthly payment would be $396.02. Divide the annual 7 percent rate by 12 to convert to a monthly rate of 0.5833 percent. When this rate is applied to the original $20,000 loan balance, the interest on the first monthly payment is $116.66. Subtract the interest from the monthly payment and the principal reduction from the first payment is $279.36, leaving a loan balance of $19,720.64.
Yearly Interest Calculation
To calculate by hand the car loan interest for an entire year, the monthly interest and principal reduction calculation must be repeated for each of the 12 monthly payments. On the example loan, the interest on the second payment would be $19,720.64 times 0.5833 percent, giving interest of $115.03, principal reduction of $280.99 and a new loan balance of $19,439.65. If this process is repeated 10 more times, the total interest on the example loan for the first year is $1,290.33.
Loan Calculation Tools
One method to automate the car loan interest calculation is to set up a spreadsheet using software like Microsoft Excel or OpenOffice Calc. Set up columns for the monthly payment, monthly interest rate, interest, principal and loan balance. Use math functions to calculate the principal, interest and loan balance each month, carrying the results into the next row for the next month's calculation. Once the spreadsheet is set up you will be able to find the interest paid for any set of car loan payments.
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