Understanding Car Loan Finance Charges: A Step-by-Step Guide

An individual may borrow a certain amount of money to buy a new or used car from a bank or other lender. The loan amount is commonly referred as the principal. Under the car loan agreement, the money is paid back in regular monthly installments over a designated period of time. Since the lender typically provides the money at a specified annual percentage rate (APR), you will pay back not only the principal, but also a certain amount of the interest (finance charges). As an example, calculate the finance charge for a $25,000 car loan given with APR of 6.0 percent for five years.

Step 1

Calculate the loan duration in months by multiplying the number of years and 12. In this example, the five-year loan would be multiplied by 12 to give you 60 months.

Step 2

Divide the loan APR by 12 and 100 to calculate the interest rate per month. In our example, the monthly interest rate is 6.0 percent / (12 x 100) = 0.005.

Step 3

Add 1 to the monthly interest rate; then raise the sum to the power that equals to the loan duration in months. In our example, the value is (1 + 0.005)^60 = (1.005)^60 = 1.34885.

Step 4

Subtract 1 from the value computed in Step 3; 1.34885-1 = 0.34885

Step 5

Multiply the monthly interest rate and the value computed in Step 3, and divide the product by the number obtained in Step 4. In the example, (0.005 x 1.34885) / 0.34885 = 0.019333.

Step 6

Multiply the loan amount by the number from Step 5 to calculate loan monthly installment payments. In the example, payments are $25,000 x 0.019333 = $483.32

Step 7

Multiply the monthly payment by the loan duration to compute the total amount of money you will pay. Given the monthly payment of $483.32, you would pay 483.32 x 60 months = $28,999.20

Step 8

Subtract the car loan principal from the total amount (Step 7); the difference is the finance charge for your loan. in our example, the finance charge is $28,999.20 - $25,000 = $3,999.20.