How to understand a car loan - four main numbers!
This resource is part of the financing of innovative services IFS auto financing Library.
How do I know interest car loan affects how much you pay for your car.
When you take a car loan to buy a car, your lender buys the car for you and allows you to repay over a period of several years Essentially, the lender gives you the service to use their money, and in exchange you compensate the lender for services by paying interest.
Most car loans are using simple interest, a type of interest, the interest expense is calculated only on the principal amount owed on the loan simple interest does not compound the interest, which saves money usually a borrower.
However, simple interest does not mean that every time you make a payment on your loan you pay equal amounts of interest and principal place, auto loans are paid down through amortization, which means you pay more interest at the beginning of your car loan at the end.
Let's you take out a car loan for 12 000 to be repaid over five years or 60 months at an interest rate of 10 Your monthly payments for this loan is 96 254 You can calculate the payment even using the following equation.
Or, you can simply use our calculator car loan for simplicity in this example, make the tax rate 0.
It is a common belief that in the 60 months of such a loan that the borrower repays the loan principal regularly as the graph below shows.
The graph above incorrectly represents the loan being repaid 200 per month until the balance reaches 0 This implies that for each payment 54 96 goes to interest payments, because 254 96 200 54 96 less interest car loan does not work that way.
The graph correct gain really looks like the following.
Notice how the gain curve is tilted so that it is less steep at the beginning of the loan at the end The reason why auto loans behave this way is that the monthly payments at the beginning of a car loan are fresher interest payments at the end of a car loan Let's look more closely why car loans work this way.
As already mentioned, the monthly payments on the loan in this example would be 254 96 Interest expense is included in this payment is based on how much you owe on the loan Thus, for the first payment on the loan, your fees interest would be equal to the part of the 10 annual interest accumulated during the first month on the amount you borrow, which means you have to pay interest of 10 12 months all 12000 Thus, the amount of interest you pay for the first payment is 100 100 December 10 months 12 000 Consequently, the first payment, you will pay your capital 96 154 96 154 254 96 100.
For the second payment of the month, you will pay a slightly smaller interest charges, because the first month payment will be refunded the principal 154 96 Thus, the second payment will include interest expense 98 71 98 71 10 12 months 12,000 154 96, and will pay the principal amount of 156 26 156 26 254 96 98 71.
This way, as you pay off a car loan, the amount of interest charges you pay decreases while the amount of capital you pay for increases, while the monthly payment remains the same for our example, the chart below shows how during the loan interest charges per month then fall as the amount of each payment helps to pay the principal increases if all monthly payments are paid as scheduled.
None of these curves are straight lines rather the interest expense line decreases at an increasing rate while the line showing how much each payment covers the principal actually increases at an increasing rate Ultimately, you would end up paying a total of 15298 15298 60254 96 of the loan 3298 3298 15298 12000 would be of interest charges.
How my car loan length long term affect my interest charges.
It is important to realize that your interest rates are not the only factor that affects the total amount of interest charges you pay for your car loan Your length of long-term car loan plays a major role in how much you pay for your car, no matter what interest rate you generally the same interest rate, the greater length of your term over your cumulative interest charge will be.
Let's continue the above example to illustrate this principle still Suppose you finance your car with 12,000 car loan that requires you to pay an interest rate 10 However, you have the choice between a loan for four years or 48 months and the loan of five years or 60 months we have discussed so far the 48 month loan would require monthly payments of 35 304 while the loan 60 months, it would still 226 96 payments by looking at the monthly payment, you may be tempted to take the loan 60 months because you can save money each month and this decision is not necessarily wrong yet, you should consider the effect of an additional 12 months will have on costs interest you pay over the loan Remember, you must pay 10 interest on the balance of your loan, so the more you owe money on your car, the more interest you have to pay.
The graph below shows how interest charges accumulate during each loan.
As you can see, the total interest charges you pay on the loan 60 months climbed higher than the loan 48 months In addition, lending rates 60 months off later than the loan 48 month, which means that the part of each of your monthly payment that covers your monthly interest cost is higher for the loan of 60 months for the loan of 48 months in total, you pay interest expenses 2608 85 for the loan of 48 months compared with 87 for the 3297 loan 60 months.
At this point, it is important to note that it is possible to have a car loan length longer term and pay less for your car with a loan from a shorter period if your loan long-term has a low enough interest rate Understanding interest rates and duration of the lending mandates and how they interact is important if you are considering refinancing a car because customers often refinance both extend their term lengths and obtain lower interest rates again, the concept of how the long-term car loan length affect your cumulative interest charges has important implications for how you can save the money on your current car loan.
Since your interest charge each month is based on how much you still owe on your loan, you can reduce your interest charges by making unscheduled payments that bring the balance of your loan When making unscheduled payments you engage in a fast car loan gain that reduce the total cost of interest you pay over your loan and can help you pay off your loan more quickly than originally planned.
Pay a debt as a car loan early is usually a good thing, because you end up paying less interest expense However, you should always consider your entire financial situation before choosing to make unscheduled payments from obviously, you need the extra money to make such a payment, but even if you do, you have to wonder if you have better uses for that extra money, for example, if you owe money on a credit card, then you're probably better repay the balance of the credit card before an unplanned car loan payment in the end, you should carefully consider whether an accelerated gain makes sense to you.
If you can not afford to pay each month for you prepared additional car, but still want to pay less for your long term car and or reduce your monthly payments, you may consider refinancing your car if you refinance to a lowest interest, you can pay much less for your car loan.
Try our auto loan refinance calculator to see how refinancing can be able to help you.
While taxes are generally a complex issue and must be developed on an individual basis, the concept of how taxes affect your car loan is simple When you buy a car, you must pay taxes on the car price you buy, which means the amount of tax you owe is added directly to your loan amount so if you want to buy a car for 20,000 and you owe taxes on it by 8, then you will be liable 1600 1 600 20 000 8 tax and therefore will need a 21600 car loan.
Note that your tax rate does not change the rate of interest you owe on your loan, however, the amount of tax you owe the borrower to pay your taxes will be included in the amount you borrow from the lender, and you have to pay interest on the total amount of taxes you borrow you do not increase your interest rate, but they increase the loan balance on which your interest charges are based.
Unfortunately, taxes are a part of life and are always inevitable, it is important that you understand how your tax rate will affect your auto loan.
While shopping for auto loans, credit cards and other financial services, you have probably come across the term in April APR stands for Annual Percentage Rate is the annual rate of finance charge you pay for your loan online or credit for auto loans, APR is the rate you pay that reflects your interest costs and all other expenses that you must pay for your loan.
To specify how much you will pay in interest costs compared to how much you will pay in interest fees plus expenses, your car loan documents will likely come with two levels each gives different information about your loan, but mathematically, they are the same in that they both give you the same payment of a city on your loan documents and both require you to pay the same amount for your car during your loan.
The lower of the two rates is your interest rate or rate notes This rate describes how much in interest you pay on your loan balance over the year.
The higher rate will your APR The APR accounts for the total finance charge you pay on your loan in a given year The financial burden is composed of two your interest costs and your financial prepaid expenses, which are various charges rolled into the loan amount that can include various loan fees and accrued interest to the date of your first loan payment Even if your prepaid finance charges are included in the principal of your loan and therefore are well paid to advance, you still pay for expenses with your car payments during your loan, making charges paid more advance fees as interest Remember, just because your APR is higher than the rate 'quoted interest to you does not mean that your lender changed loan conditions, it offers you.
Note, the loan amount is the balance of your loan principal, which is the amount you borrow Interest costs are those paid in a period of 12 months.
Note, the loan amount is the balance of your financed amount or the amount you need to buy or refinance your car costs of prepaid interest is paid during the period of 12 months.
Please note, although these equations are useful for understanding these two rates, they do not necessarily reflect how you calculate the two rates, however, you can read much more about how working here in April, there including how to use the above equations to correctly estimate your rating rate or April
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