Car payment calculation is not simple math. It requires a rather complex business math formula that is not easily done by hand and most people are not capable, or not willing, to take it on. It’s not as simple as dividing loan amount by the number of months in the loan. Finance charges (interest), which change every month, must be accounted for.

It’s much easier to use a hand-held business calculator, such as the HP 12c or HP 17b, or, even better, use an easy online auto loan calculator which does the math for you.

To use a car loan calculator, you must know the amount being financed, the number of months you want to finance, and the interest rate. You’ll also need to know the down payment amount, if any, and the value of your trade-in vehicle, if any. You also need to know the sales tax rate that applies to your home location, not where you buy your car.

How Car Payments Work

It’s a fact of life. Anytime you borrow money for a car, a house, or for credit card purchases, the lender wants you to pay an extra amount (interest) for your use of his money. The more money you use (borrow), and the longer your payoff term, the more you pay.

The way in which car loan payments are calculated sets a fixed monthly payment figure that includes two parts: 1) a part that repays some of the principal ( the amount you borrow), and 2) a part that pays interest (finance charges) on your outstanding balance.

Since your loan balance (principal) decreases with each monthly payment, the amount of interest in your payment also decreases and the amount going towards your loan balance increases. 

This means that in the early months of your loan, you pay a lot of interest and less principal. As you move toward the end of your loan, you pay less interest and more principal. In other words, you pay off your loan faster at the end than at the beginning. 

No two month’s payments are exactly the same in the amounts of the two parts, although the total payment is always the same (except for possibly the last payment which is usually less).

One possible problem with the way that car loans are structured is that the small amount of principal being paid in the beginning of the loan term may not pay the loan balance down as fast as the value of the vehicle depreciates.

This means you may be “upside down” — you owe more on your loan than your car is worth — during much of your loan term, which can be a problem if you decide to sell or trade before your loan is paid off, or nearly paid off. It can also be a problem if your car is stolen or totaled in an accident. Insurance companies pay you what the car is worth, not the amount you still owe on your loan. 

If you decide on a long-term loan (more than 48 months), or have a high interest rate, or make little or no down payment, or roll over negative equity from a previous car loan, you are almost assured of being upside down for most of your new loan term.

Some banks and loan companies allow you to make extra payments or pay more each month toward principle, which ends your loan sooner, lowers total finance costs, and reduces the chance of being upside down. Contact your bank or loan company to make arrangements.

Calculating car loan payments is easy if you use an online car loan calculator.

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Car leasing has it’s advantages and disadvantages. Here is a summary:

Pros:
- Get new car every 2-4 years, with latest features and safety equipment
- Lower monthly payments
- Usually no down payment
- Car is always under warranty
- Lower sales tax (in most states)
- Avoids used car selling/trading hassles
- Automatic GAP insurance included (most leases)

Cons:
- Low payments doesn’t build owership equity
- Difficult to get out early – best if completed as scheduled
- Must keep car is good condition, or pay at end
- Must drive only average miles (about 15K/year) or pay at end
- Extra fees at beginning and end
- Not allowed to make modifications to car
- More complex, hard to get good deal if you don’t understand how it works

Car leasing is great for some people, particularly for those who take the time to understand how it works and learn how payments are calculated. If you normally trade cars every 2-3 years, drive average miles, and take good care of your cars, you can benefit from leasing.
Leasing is not so great for people who don’t understand it, have an unstable lifestyle, are likely to want to end the lease early, don’t take good care of their cars, and can’t predict the number of miles they will drive.

Car leasing might be the right answer for first time car buyers — but maybe not.

See LeaseGuide.com for additional information, advice, leasing kit, and lease calculators.

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David, 17, recently graduated from high school, landed a good paying job, and wanted to buy a new car.

His thought was that he would go to his neighborhood Ford dealer where he had been admiring a bright red Focus model that he felt he could afford, and arrange for a convenient loan to pay for it. He could easily get approved for the loan because his father knows the owner of the dealership. 

The car cost $12,000 with discounts and rebates. He thought a 5 year (60 months) loan would be about right because he figured payments to be $200 a month ($12,000 divided by 60 months), which he could easily afford.

David was wrong — in many ways. Let’s see why.

So what’s wrong with David’s thinking?

Age Requirement
First, he must be at least 18 years old  to be legally responsible to sign contracts, including sales contracts and car loan agreements. He would have to show proof of age before signing.

Loan Approval
Second, ignoring the age problem for a moment, car dealers don’t approve loans or make loans, so it doesn’t matter that David’s dad knows the owner of the dealership. Dealers work with banks and finance companies to arrange loans for customers. It’s the bank or finance company who approves loan applications and grants loans. Dealers sometimes “screen” customers as preliminary way to weed out customers who have impossible credit. 

Credit History
Next, having recently graduated and just getting a new job, David does not have an established credit history. He has never had a credit card, department store account, or a loan. The fact that he has a new job doesn’t help if he’s been working less than 6 months.

If he was old enough (18 or older, see above), he could get a family member to co-sign the loan agreement, which would help him get approved. A co-signer would be responsible only if David fails to pay on his loan.

But since David is not yet 18, he can either wait until he becomes of legal age, or he could have his parents buy a car in their name and add him to their insurance policy as the regular driver.

Calculating Payments
Finally, David doesn’t understand how car loan payments are calculated. It’s not a simple matter of dividing the car’s cost by the number of months in the loan.

In fact, it’s a rather complex business math calculation that takes into account a monthly finance charge (interest), that will significantly increase his total cost, especially for loans 60 months long that have higher interest rates than shorter loans. The calculation must be performed with a business calculator or online auto loan calculator.

Length of Loan
Furthermore, even if David were to be able to get the car loan, a 60-month loan is too long for a teenager  who will become tired of his car long before 5 years is up. More than likely, his tastes will change and he’ll get future pay raises that will allow him to afford (want) better, more expensive cars. 

Unfortunately, with such a long-term loan, he’ll be “upside down” for most of the term of the loan, making it financially troublesome to try to sell or trade before the loan is paid off. He may be tempted to trade and have the dealer roll his “negative equity” into a new car, which is not usually a good thing to do.

Other Costs
Further still, we wonder if David has considered the other costs of owning and driving a car. A car’s purchase cost is only a part of the overall cost of ownership. As a young male driver, his monthly insurance costs could easily exceed his loan payment amount. Then there’s gas, maintenance, repairs, tires, taxes, and license fees.

Summary
Unless someone buys a car for David, he should wait until he is at least 18 years old, has a stable income, has an established credit history, and understands how car buying and financing works.

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Car leasing is extremely popular because it offers a more affordable method of auto financing. It allows you to have lower monthly payments than with traditional auto loans. About one out of every five vehicles driven by automotive consumers in the United States are leased.

But car leasing is not for everyone. Is leasing good for a teen’s first car? What are the pros and cons of leasing?

Leasing is a little more complicated than buying with a loan, so you should take the time to learn about leasing, and be sure it’s right for you before making a decision.

What is a Lease?

Both leasing and buying a car with a loan are simply two different methods of financing. Where a purchase loan is a method of financing the ownership of a vehicle, leasing is financing the use of a vehicle for a specified number of months, similar to renting but not quite the same thing.

A lease is a formal contract with a bank or leasing company that allows you to drive a car and only pay for the portion of the vehicle’s value that you use up during the time you’re driving it. You agree to pay for insurance, licenses, taxes, repairs, and maintenance.

Contrary to some misguided opinion, car leasing is not renting, and is not a dealer scam. It’s a form of financing that is a bit more complicated than buying with a loan, and therefore easier to make mistakes for those who don’t understand it well.

The leasing provider retains ownership and title to the vehicle throughout the lease. At lease-end you can simply return your vehicle to the provider, or purchase the vehicle and continue driving it.

Leasing Benefits

A car lease offers the following benefits when compared to purchase loans:

- Lower monthly payments
- More car, more often
- Minimum or no down payment
- Smaller sales tax bite in most states
- No used-car headaches at end

Who Provides Leases?

Contrary to popular belief, car dealers do not lease cars. Banks, credit unions, and financial divisions of major car manufacturers lease cars. Dealers simply act as agents of a leasing provider, such as Ford Motor Credit or GMAC, to arrange the lease on a customer’s behalf. Dealers typically work with more than one provider.

Should You Lease?

Car leasing makes sense for many people, but not for others. Here’s how to determine if you are a good leasing candidate:

• Are you willing to trade ownership of your vehicle for lower monthly payments? Leasing is a great way to lower your payments or drive a better car for your money, but you must be comfortable with having no ownership of your vehicle, unless you purchase at lease-end.
• Can you stick with your lease until the end? Leases require you to commit to driving your vehicle for a specific number of months — typically 24, 36, 48, or 60 months. If you feel your lifestyle, your finances, or simply your taste in cars may change significantly in future months, you may not be a good lease candidate. To end a lease early is usually troublesome and costly.
• Do you drive more than 15,000 miles annually? If your answer is yes, you may not be a good candidate because lease contracts are typically written with an annual mileage limit, typically 10,000-15,000 miles. If you drive more that the specified number of miles you will pay a fee for every mile over the limit.
• Do you typically keep your vehicles in good condition and change vehicles every few years? If so, you may be right for leasing. Car lease providers require you to keep their vehicle maintained and repaired, with no more than normal wear and tear. If you don’t, you’ll be charged at the end of your lease.
• How is your credit rating? If you have a history of paying your bills on time and don’t have excessive debt, you are a good lease candidate. Otherwise, you may be required to make a large down payment and pay higher finance charges or, worse, be refused the opportunity to lease.

Lease Price

The most important element of a good car lease deal is the price of the vehicle. Regardless of whether you buy or lease, you should always get the best possible price first. When leasing, this price becomes the capital cost, or “cap cost.” Prior loan balances and fees may be added. Rebates, discounts, down payments, and trade-in credit are subtracted. The lower the capital cost, the lower your monthly payment. This is the only element of a lease deal that a dealer directly controls.

The remaining elements of a lease — money factor, residual value, and related fees — are controlled by the lease provider.

Money Factor

Since a lease is simply another form of car financing, interest charges apply. These interest charges are known as money factor. Money factor is expressed as a very small number such as .00375, which is equivalent to 9% annual interest rate. Again, a small money factor results in lower monthly lease payments.

Residual Value

Residual value is an estimate of a vehicle’s wholesale value at the end of a lease term. The longer the lease, the smaller the residual value. Your lease payment is primarily determined by the difference between cap cost and residual value, which is the amount that the value of the vehicle depreciates during the lease. Finance charges and sales tax will also be included in your monthly payment.

When you get lease offers from a dealer, you should be able to use a lease calculator to verify the accuracy of the dealer’s figures.

Fees

There may be certain fees associated with your lease. The fees that lease providers charge vary both in kind and amount. One of the most common is an acquisition fee, which is an administrative charge for the work in initiating a lease. Another common fee is a disposition fee, usually charged at the end of your lease when you return your vehicle.

Due at Signing

At the beginning of your car lease, you will be asked to pay the first month’s payment, a security deposit, your down payment, if any, and applicable miscellaneous fees associated with licensing a vehicle in your state. You will also be asked to show proof of insurance.

Leasing might be right for a teen who is 18 years old, has established credit, and has a steady income. However, many younger teens who might want to lease their first car must rely on their parents until they are old enough to lease on their own.

More information

For more details about car leasing, which cars make the best lease vehicles, how to find leasing deals, and how to calculate monthly lease payments, see LeaseGuide.com.

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Assuming you’ll buy with a loan, you will want to have a monthly car payment that will fit within your current income, after considering all your other expenses. Don’t make the mistake of buying based on future expectations — a forthcoming raise, a new job, or other potential improvements in your finances. Your expectations might not come to reality and you’ll be stuck with a car you can’t afford. Base your purchase only on current, stable finances.

Debt and Income
Most lenders look at your income and debt, as well as your credit score, to make a decision about how much you will be allowed to borrow, or if you will be approved at all. If your combined monthly debt (credit car payments, rent, etc.), including the new car payment, exceeds about 36% of your gross monthly income, you may not be approved. If a lower car payment will get you in under 36%, then you might be approved but at a lower loan amount.

Shop for Auto Loans
Shop at local banks, credit unions and loan companies for your auto loan. Since the bank or loan company will check your qualifications, you’ll know fairly quickly how much car you’ll be able to afford. This will allow you to go shopping looking at only those cars you know you can afford. Just be aware that each loan application causes a query against your credit history. Multiple auto loan queries within a 45 day period only counts as a single query and lowers your credit score only by a few points. Many people hesitate to shop for loans, believing that each application hurts their score, which is not the case.

Another way to buy is from a used car dealer who finances his own loans. These dealers, such as Drivetime.com, specialize in working with people who have less-than-perfect credit.

Use a Calculator
If you want to begin by doing some of your own affordability calculations, use an online auto loan calculator to play around with various car prices, loan terms, and down payments to find out how much car you can afford, based on an affordable monthly payment.

Don’t Negotiate Payments
One caution: Don’t negotiate monthly payments with a car dealer if you don’t understand how he is calculating that payment. Instead, negotiate car purchase price and let the dealer tell you what monthly payment it produces. If the payment is too high, go back to the selling price and get it lower, if possible. Getting an affordable monthly car payment doesn’t mean you’re getting a good deal on the price of the car.

Other Costs That Affect Affordability
Also don’t forget that you will have other expenses associated with the ownership and operation of your car. One of the most significant is auto insurance. For first time drivers, insurance can be very expensive. Also consider gas, oil, maintenance, annual inspections and taxes.

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The answer? Yes, under some conditions. Let’s explain.

It is a common situation, especially with young people who have never had a loan, never had credit cards, or never borrowed money for a car. Without a history of prior loans and payments, there is no credit history and no credit score, which is the number that represents credit rating.

In fact it is not quite sufficient to simply have a good credit score to get a car loan — or any loan. You may also need to have an established steady income (a job) and no excessive debts. You should have no recent bankruptcies or auto repossessions, which you wouldn’t be likely to have anyway if you have no credit. 

So how is it possible to buy a car with a loan when you have no credit record and no credit score?

Buying a car with no credit is only possible if you pay cash, or if you get a loan from family or friends — or if you have someone who can co-sign with you on a loan. Having a co-signer is the most common way that most people buy a car with no credit.

A co-signer is not a co-owner. The loan is in both names but the car’s title is only in the name of the primary borrower (unless he wants both names on the title, which is typical for a husband and wife). Only if the primary borrower defaults (misses payments, or stops payments) does the co-signer take over. Even then, the co-signer only makes payments. The car still belongs to the primary borrower, even though the co-signer pays. The co-signer assumes no owership or equity in the car, even if they made most of the payments.

It is also important to know that both the borrower’s and co-signer’s credit are affected negatively if neither can make payments and the car is repossessed.

If you have no credit, having a co-signer on your car loan is a great way to build credit and establish a positive credit history for the next time you need a loan to buy a car.  Just make sure you make all payments on time and don’t miss payments. It also helps to get two or three credit cards or department store cards but don’t apply for them all at the same time. Spread out your applications over a period of three months or more. Charge to the cards frequently. Pay off most of your balance each month.  Make payments on time and keep low (but not zero) balances.

If you want to buy a car with no credit, there are some solutions, the best of which is to have a co-signer. Without a co-signer, you are very limited in your options. You could consider a special type of used car dealer, such as Drivetime.com, who has locations all over the country, and provides their own loans to people with no credit or poor credit.

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