Auto loans use simple interest, which means the balance of your auto loan determines your interest charges. An amortization schedule outlines how your interest and principal are paid in a simple interest loan. Here’s how simple interest works, and how you can save money when you finance a vehicle.
Auto Loan and Simple Interest
A loan that amortizes means that the principal is reduced over time, and requires monthly (or regular) payments. Your monthly payments are applied to both the principal of the loan and your interest charges that accrue. Most car loans use a simple interest formula. This means that your interest charges accrue daily based on the balance of your principal. The less you owe, the less you pay in interest charges.
The benefit of a simple interest formula is that with each on-time payment, you’re reducing your interest charges because you’re lowering your principal balance. This also means you're charged less interest each time your payment rolls around.
To see how much interest you’re charged per payment, you can look up an amortization schedule and enter your auto loan terms. Here’s a quick example:
Auto loan terms:
$20,000 car loan / 60-month loan term / 10% interest rate / $424.94 monthly payment
- First payment of $424.94:
- Interest $167 / Principal $258 = Balance $19,742
- Second payment $424.94:
- Interest $165 / Principal $260 = Balance $19,481
- Third payment $424.94:
- Interest $162 / Principal $263 = Balance $19,219
As you can see, with each monthly payment you lower how much you pay in interest charges. Since there’s less interest accrued, more of your monthly payment is applied to your principal every month.
Planning Your Next Car Loan
Now that you know how auto loan amortization goes, you can plan your next car loan with confidence. It’s important to set yourself up for success and choose loan terms that benefit you.
While you may have some say in your loan terms, your credit score is a major player in qualifying for vehicle financing and determining your interest rate. With a low credit score, you’re more likely to qualify for a higher interest rate. If this is the case, then it’s typically more beneficial for you to choose a shorter loan term and/or a more affordable vehicle.
Opting for an expensive vehicle with a long loan term and a high interest rate puts you at risk for negative equity. Negative equity is when you owe more on the car than it’s worth. A higher interest rate can mean more of your monthly payment is applied to interest each month, and less to your principal – which can make it hard to lower your loan balance quickly.
If you’re a bad credit borrower and you’re concerned about paying excessive interest charges, it’s wise to choose a used vehicle. They’re usually more affordable, and you’re more likely to qualify for a loan on a lower sticker price.
Another way to reduce interest charges is by putting more money down on the loan. Saving a large down payment can take time, but lowering your loan amount means fewer interest charges can accrue.
If you have poor credit, a down payment requirement is customary. A good savings goal is at least $1,000 or 10% of the vehicle’s selling price. Most subprime lenders require at least that, and you can always put more down. The more cash you bring to the table, the fewer interest charges accrue over the course of your loan.
Take the Leap Into Vehicle Financing
Being prepared for an auto loan is a great first step in financing a vehicle. However, with a lower credit score, it can be difficult to find a lender that can assist you. There are lenders willing to help borrowers with credit challenges, though: subprime lenders.
These lenders look at more than your credit reports. Instead of just relying on your credit history, they examine your income, overall stability, and require a down payment. They’re signed up with special finance dealerships and we want to help you get in touch with one.
Here at Auto Credit Express, we’ve created a network of dealers that are signed up with subprime lenders, and we’ve been helping borrowers find lending resources for over 20 years. Get started today by completing our free auto loan request form. Using our network, we’ll look for a dealership in your local area that has bad credit options. Take the leap into vehicle financing with us today, with no cost and no obligation!