When you’re financing a car, all the excitement can make it hard to focus on the things that matter – like how your total cost is calculated! Auto loan paperwork can be lengthy, filled with lender jargon, and sometimes can feel rushed. Knowing what you’re paying for starts with understanding principal and interest in auto loans.
Auto Loan Definitions
As you may know, the price in the window of the car you’re looking to buy is just the start of the total cost if you’re financing. Unless you qualify for a 0% interest loan deal, a good chunk of the cost comes from the selling price of the car and the interest paid to the lender.
Here are some quick definitions:
- Negotiated selling price – The price of the car you and the dealer agreed to.
- Principal – The amount that you're borrowing from the lender, could include additional fees and charges above the vehicle's negotiated selling price.
- Interest rate – The cost of borrowing money from the lender to buy the car, as a percentage. Largely determined by your credit score.
- Interest charges – The charges which accrue over time on the principal of your loan. Your loan balance and interest rate determine how much interest you pay over the course of your loan.
Your interest rate, expressed as a percentage, determines how much interest you’re charged over time. Nearly every car loan uses a simple interest formula, meaning your interest charges accrue daily based on your loan balance. Each time you make a car payment, part of that payment is applied to the interest that accrued and the rest is applied to your principal. You can ask to see an amortization schedule that outlines how much your car payment is applied to your principal and interest each month.
Over time, less of your monthly payment is being used to pay interest, and more is being put toward your actual loan balance. By the time you're near the end of your loan, a majority of your payments are applied to the principal until it’s paid off.
Financing a Car the Smart Way
There are ways to save money on interest charges, and we’ve got a few tactics you can try. A few good ways to skip out on paying some interest charges include:
- Put money down – Having a down payment to lower the selling price of the car means a lower loan balance. The less you borrow, the less there is to be charged interest on.
- Rate shop for low interest rates – Rate shopping involves applying for vehicle financing with multiple lenders within two weeks. Multiple hard credit pulls within 14 days (all from the same type of lender) lead to only one hard pull impacting your credit score. If you apply with a few different lenders in this small window, you can look for the lowest interest rate for your situation.
- Choose a short loan term – Since most auto loans are simple interest, the length of your loan term plays a part in your overall interest charges. The faster you pay down your car loan, the less interest you pay.
- Pay extra when possible – Auto loans typically last for 48 to 96 months. In that years-long timeframe, you may have the opportunity to pay extra on your loan, and it's a good idea to take it if it comes. Windfalls such as stimulus checks and tax refunds can really help reduce your loan balance quickly and decrease interest charges.
Of all the methods to reduce your interest charges, the simplest way to save money when you need to finance a car is by having the best credit score you can. Your credit score is the biggest factor in determining your interest rate. The better your credit score, the lower the rates a lender may offer you. However, the opposite is true, too. A lower credit score can mean having to shell out more cash to get the vehicle you need.
Need Bad Credit Lending Resources?
If you have less than perfect credit, you’re not alone. Sometimes life gets in the way and hurts your credit score, or you simply haven’t been able to start a good credit history just yet. Credit challenges can be a roadblock in getting an auto loan, but here at Auto Credit Express, we’ve got you covered.
Over the last 20 years, we’ve cultivated a nationwide network of dealerships that are equipped with lenders to help bad credit borrowers get the car loans they need. Fill out our free auto loan request form and we’ll look for a dealer in your local area.