How Car Loan Interest Is Calculated in Canada
Car loans in Canada use simple interest, not compound interest. Here's how your payment is split between principal and interest — and how to pay less.
Understanding how car loan interest is calculated helps you see exactly what you're paying and how to reduce it. In Canada, most car loans use simple interest with amortized payments — which is good news for borrowers.
Simple Interest vs Compound Interest
Canadian car loans use simple interest, not compound interest. This means interest is calculated only on the remaining principal — not on accumulated interest.
- Simple interest: Interest = Principal × Rate × Time
- Compound interest: Interest earns interest (credit cards work this way)
Simple interest means paying extra toward your principal directly reduces the interest you pay over the life of the loan.
How Your Monthly Payment Is Calculated
Your monthly payment is calculated using an amortization formula that splits each payment between principal and interest:
Monthly Payment = P × [r(1+r)^n] / [(1+r)^n - 1]
Where:
- P = Principal (loan amount)
- r = Monthly interest rate (annual rate ÷ 12)
- n = Total number of payments (term in months)
Example: $25,000 at 10% for 60 months
- Monthly rate: 10% ÷ 12 = 0.00833
- Monthly payment: $531
- Total interest: $6,860
- Total cost: $31,860
How Amortization Works
In the early months of your loan, most of your payment goes toward interest. As the principal shrinks, more of each payment goes toward principal.
| Month | Payment | Interest | Principal | Balance |
|---|---|---|---|---|
| 1 | $531 | $208 | $323 | $24,677 |
| 12 | $531 | $178 | $353 | $21,238 |
| 30 | $531 | $130 | $401 | $15,483 |
| 48 | $531 | $71 | $460 | $5,164 |
| 60 | $531 | $4 | $527 | $0 |
This is why making extra payments early in the loan saves more interest than making them later.
How to Pay Less Interest
1. Make Extra Payments
Every extra dollar you pay above your monthly payment goes directly to principal. On a $25,000 loan at 10%:
- $50/month extra: Saves $1,580 in interest, pays off 7 months early
- $100/month extra: Saves $2,820 in interest, pays off 14 months early
Use our Loan Interest Calculator to see how much you can save.
2. Choose a Shorter Term
A shorter term means less time for interest to accrue:
- 60 months @ 10%: $6,860 interest
- 48 months @ 9%: $4,760 interest (rate often drops with shorter term)
Savings: $2,100
3. Make a Larger Down Payment
A larger down payment means a smaller principal, which means less interest:
- $0 down on $25,000: $6,860 interest
- $5,000 down on $20,000: $5,488 interest
Savings: $1,372
4. Make Biweekly Payments
Instead of 12 monthly payments, make 26 biweekly half-payments. This equals one extra monthly payment per year, saving interest and paying off the loan faster.
APR vs Interest Rate
The APR vs interest rate distinction matters: APR includes fees, giving you the true cost of the loan. Always compare APRs, not just interest rates.
The Bottom Line
Car loans use simple interest, which means extra payments directly reduce your interest cost. Use our Loan Interest Calculator to see how extra payments can save you thousands, and our Car Payment Calculator to estimate your monthly payment.
See also: What interest rate can I get? and 72-month car loans.
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