How to Calculate Car Loan Payments — Amortization & Interest Explained
Introduction
Financing a vehicle is one of the most common major financial decisions adults make, yet many sign loan agreements without fully understanding how their monthly payment is calculated or how much interest they’ll ultimately pay. Learning how to calculate car loan payments manually—using the standard amortisation formula—gives you the power to compare offers, avoid predatory terms, and make informed choices that save you thousands of pounds over the life of the loan. This guide breaks down the mathematics behind auto loans, explains key concepts like amortisation schedules and APR, and provides realistic examples to help you model different scenarios—from short-term loans with low interest to long-term deals with high APRs. Whether you’re buying new or used, this knowledge is essential for responsible car ownership in the UK.
The Anatomy of a Car Loan
An auto loan is a secured, fixed-rate loan where the vehicle serves as collateral. Key components include:
- Principal: The amount borrowed (car price minus deposit).
- Term: Loan duration, typically 12–84 months.
- APR (Annual Percentage Rate): The true annual cost of borrowing, including interest and fees.
- Monthly Payment: Fixed amount paid each month until the loan is repaid.
Unlike credit cards (revolving credit), car loans are amortising, meaning each payment reduces the principal while covering accrued interest.
The Amortisation Formula
The monthly payment is calculated using this formula:
PMT = P × [r(1 + r)ⁿ] / [(1 + r)ⁿ – 1]
Where:
P= Principal loan amountr= Monthly interest rate (APR ÷ 12 ÷ 100)n= Total number of payments (term in months)
Example:
- Car price: £20,000
- Deposit: £4,000
- Principal (P): £16,000
- APR: 6% → r = 0.06 ÷ 12 = 0.005
- Term: 48 months → n = 48
PMT = 16,000 × [0.005(1.005)⁴⁸] / [(1.005)⁴⁸ – 1] = **£375.76/month**
Total repaid: £375.76 × 48 = £18,036.48
Total interest: £18,036.48 – £16,000 = £2,036.48
Understanding the Amortisation Schedule
An amortisation schedule shows how each payment is split:
- Early payments: Mostly interest (e.g., Month 1: £80 interest, £295.76 principal)
- Later payments: Mostly principal (e.g., Month 48: £1.87 interest, £373.89 principal)
This is why longer terms cost more in interest—you pay interest on a higher balance for longer.
Key Factors That Affect Your Loan
- Deposit size: A larger deposit reduces principal and interest.
- Loan term: Shorter terms = higher payments but far less interest.
- APR: Even 1% difference can save hundreds. Your credit score heavily influences APR.
- Fees: Some lenders add arrangement or admin fees—check if they’re included in APR.
UK-Specific Considerations
- APR is legally required to include all compulsory fees, making comparisons easier.
- Voluntary termination: Under UK law, you can return the car after paying 50% of the total amount payable (including interest).
- GAP insurance: Recommended if your deposit is below 20%, as cars depreciate quickly.
Pro Tips & Common Mistakes
- Get pre-approved: Secure a loan from your bank or credit union before visiting dealers.
- Focus on total cost, not just monthly payment: A 72-month loan may seem affordable but costs far more long-term.
- Avoid balloon payments: Some PCP deals have large final payments—these aren’t standard auto loans.
- Check early repayment charges: Most UK lenders allow early repayment but may charge up to 58 days’ interest.
- Never skip the amortisation schedule: It reveals the true cost of your loan.
Practical Applications
- Budgeting: Use the formula to ensure the payment fits your monthly outgoings.
- Negotiation: Know your max loan amount before discussing price.
- Refinancing: If your credit improves, recalculate to see if refinancing saves money.
- Extra payments: Even small overpayments reduce interest and shorten the loan.
Practice Calculating Car Loans
Scenario 1: New vs. Used Car
- New car: £25,000, 3% APR, 48 months, £5,000 deposit → Loan: £20,000
- Used car: £15,000, 7% APR, 48 months, £3,000 deposit → Loan: £12,000
Task: Calculate monthly payment and total interest for both. Which is cheaper overall?
Scenario 2: Term Comparison
Loan amount: £18,000 at 5% APR
- Option A: 36 months
- Option B: 60 months
Task: Calculate payment and total interest for each. How much extra interest does the longer term cost?
Scenario 3: Impact of Deposit
Car price: £18,000, 6% APR, 48 months
- Deposit A: £1,800 (10%)
- Deposit B: £3,600 (20%)
Task: Compare monthly payments and total interest. How much do you save with the larger deposit?
Scenario 4: Extra Payments
Loan: £15,000 at 5.5% APR over 60 months → Payment: £286.50
You pay an extra £50/month.
Task: Estimate how many months you’ll shave off the loan and how much interest you’ll save.
How is car loan interest calculated in the UK?
UK car loans use daily compounding but are repaid monthly via amortisation. Interest is calculated on the outstanding balance each day, but your monthly payment is fixed using the standard amortisation formula.
What’s a good APR for a car loan in the UK?
As of 2025:
- Excellent credit: 3–5% APR
- Good credit: 5–8% APR
- Poor credit: 8–15%+ APR
Always compare APRs—not just monthly payments.
Should I choose a 36-month or 60-month loan?
A 36-month loan costs less in interest and gets you debt-free faster. Choose it if you can afford the higher payment. A 60-month loan lowers monthly outgoings but increases total cost—only use if necessary for budgeting.
What is negative equity (“upside-down” loan)?
This occurs when you owe more on the loan than the car is worth. It’s common in the first 1–2 years due to rapid depreciation. A larger deposit (≥20%) helps avoid this.
Can I pay off my car loan early in the UK?
Yes. Under the Consumer Credit Act, you can repay early. Lenders can charge up to 58 days’ interest as an early settlement fee, but many waive it.
How do I compare loan offers?
Compare APR (not interest rate alone), total amount payable, and monthly payment. Use the amortisation formula to verify dealer quotes.
Does my credit score affect my car loan?
Significantly. A higher credit score (e.g., Experian 880+) qualifies you for lower APRs. Check your report before applying.
What's the difference between a personal loan and dealer finance?
- Personal loan: Unsecured, fixed rate, you own the car immediately.
- Dealer finance (Hire Purchase): Secured on the car, may include fees, you don't own it until final payment. Always compare both options.
Conclusion
Understanding how to calculate car loan payments empowers you to make informed vehicle financing decisions and secure the best possible terms. By mastering the monthly payment formula, comparing total costs across different loan structures, and factoring in the impact of down payments and interest rates, you can approach car purchases with confidence and avoid costly mistakes.
Remember that securing pre-approval, negotiating the purchase price separately from financing, and comparing offers from multiple lenders often saves thousands over the loan term. Whether you choose a personal loan, dealer finance, or PCP agreement, always calculate the total cost of ownership to make the most financially sound decision. Calculate your car loan payments instantly with our Car Loan Calculator to compare options and find the best financing deal for your next vehicle.