How Does Car Loan Interest Work?
When you opt to purchase a car using a loan, the lender buys the car on your behalf and then gives you the chance to repay the loan over a certain period of time. In other words, the lender shoulders the burden of purchasing the vehicle using its resources and you repay them by paying interest on top of the loan principal.
Most lenders use simple interest on their car loans. Simple interest is a form of interest that’s only calculated on the principal amount. The good thing about simple interest is that it does not compound in terms of interest charged on the loan. This means that a borrower is able to save some money.
Factors about car loans
The price of cars in the country and around the world has continued to rise over the past few years. That’s probably why many people are opting for auto loans to buy cars. Some people choose auto loans that stretch over longer periods in order to have minimum monthly payments.
Here are three major factors about car loans:
- Interest rates for auto loans vary largely and change almost daily
Before you walk into a showroom or contact a dealership, it is important to find out about their current auto loan rates. The option would be to get a preapproval from a credit union or a bank prior to selecting your preferred car.
- Simple and compound interest
Auto loans comprise simple and compound interest. This is an advantage to you as a borrower since you only pay on the agreed simple or compound interest.
- Amortization
The other thing to know about auto loans is that they are amortized. This means that your monthly payments go towards paying both the principal and interest.
How and When Do I Pay Car Loan Interest?
Assuming you take a car loan worth $15,000 to be paid back over a period of 5 years at an interest rate of 10%. It is up to you to calculate the interest using an online calculator or a formula recommended by your lender.
After determining how much interest you are supposed to pay, the next thing is to find out the amount of down payment needed by the lender.
How Does My Car Loan Term Length Affect My Interest Charge?
The duration or term of your loan is another major factor that affects the amount of interest charged on the auto loan. The longer the term or duration of your loan, the higher the interest and vice versa.
How Can I Reduce My Interest Charges on My Auto Loan?
The best way to reduce your interest charges is to make unscheduled payments that will help lower your loan balance. When you decide to make unscheduled payments, you are basically accelerating the car loan payoff. This will significantly reduce the total amount of interest charged.
In general, auto loans help many people to own cars. According to Lantern by SoFi, car loan refinancing can “lower your car loan payments and free up some cash”. That’s why it is important to know how to refinance your car loan in order to reduce the interest rates charged.