One of the most important things to figure out before you take out a car loan is how much it’s going to cost you to pay back, both on a monthly basis and overall, and it’s not as simple as taking the loan and dividing it by the number of months unfortunately because interest is the deciding factor.
Now you can use an online loan calculator to do this in a snap, but if you want to do it the old-fashioned way or you just want a clearer understanding of how the calculator works, here are the steps.
Get The Base Numbers
Before you can calculate your monthly car payments, you need to know what Numbers are going into that calculation. You need to know the total loan amount, which is most likely the cost of the car minus any down payment you’ve already made.
For this example, we’re going to say $12,000. You’ll need the total loan period, for our case we’ll say 60 months (5 Years). And finally, you’re going to need the interest rate.
This is the complicated one because it’s dependent on whether your loan agreement has a fixed interest rate or a variable interest rate. Fixed makes this calculation easy because you can just take the fixed rate.
Variability makes this calculation impossible because there’s no way to be 100% accurate, but you can take the average interest to get a close enough monthly amount with the understanding that it could fluctuate. For our example, we’ll say the interest rate is 6% annually.
The Formula
The formula for calculating monthly payments is A = P (r (1+r)^n) / ( (1+r)^n -1 ). That’s a horrible complicated mess to look at but we’re going to break it down into separate parts.
First, let’s define our symbols:
A = Monthly Amount
P = Principle Amount/Total Loan Amount
r = Interest rate per month
n = Total number of payments
To calculate r, take the annual interest rate and divide by 12 for each month of the year, in our case, that’s 6/12 = 0.5% per month. (careful not to fall into that trap though, remember all percentages are presented as decimals in calculations, so 0.5 in a calculator is actually 50%, what you should be entering is 0.005)
Calculating monthly payments means taking our total amount, dividing it by the number of payments, and then adding interest, and that’s exactly what that formula does, just condensed into 1 formula because mathematicians love to be efficient.
If we plug in our numbers: A = 12000 (0.005 (1+0.005)^60) / ( (1+0.005)^60 -1 )
Then our monthly amount comes to: $231.99.
Personally, we don’t recommend calculating your monthly car payments manually if you don’t need to, but it’s always helpful to know how things work before you start using the shortcuts.
Thanks for reading!