Auto Financing 101: How Does Interest Work?

If you’re in the beginning stages of purchasing a vehicle, your focus might be on the color, gas mileage, design and high-tech features that are specific to the make and model of your car-to-be. While those factors play an important role in your car-buying decision, knowing the nitty-gritty details of your auto financing is important, and a big part of understanding is knowing how interest works.


Auto Financing Interest

Generally, when you take out a car loan or auto financing, the approving lender (typically a bank or finance company) lets you pay the money back through monthly car payments over a defined number of months or years. You are charged interest to compensate the lender for allowing you to borrow money or pay for your purchase over time.

Most car loans and auto financing use simple interest, which is interest that is calculated only on the unpaid principal. Auto financing with simple interest is generally interest bearing where the amount of interest you owe is calculated on a daily basis on the unpaid principal balance outstanding. This means the faster you repay the principal balance, for example by paying more than the standard monthly payment, the lower your interest charge will be.


Factors that Influence the Interest Rate

A few key factors that can influence the rate of interest you will pay on your auto financing include:


  1. Your credit score: Generally, the higher your credit score, the lower the interest rate you will have to pay on financing.

  2. Size of down payment: The more money you have for a down payment, the less you will have to borrow on the auto loan or financing, which means you will pay less interest.

  3. Length of car loan or financing: The longer the loan term, the more interest you will pay when compared to a shorter term.


Improving your credit, saving for a down payment and knowing how your interest is calculated can make a big difference in how much interest you pay.

Are you in the market to purchase a vehicle but need help getting approved for financing due to having bad credit or no credit history established? A car dealer enrolled in the Credit Acceptance auto finance program can help. Start your auto financing pre-qualification today!