How Are Auto Loans Amortized?
Auto loans use simple interest, which means your auto loan balance determines your interest costs. An amortization schedule describes how your interest and principal is 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 apply to both the principal of the loan and your accruing interest charges. Most auto loans use a simple interest formula. This means that your interest charges accumulate daily based on your principal balance. The less you owe, the less interest you pay.
The advantage of a simple interest formula is that with every payment on time, you reduce your interest costs because you reduce your principal balance. It also means that you pay less interest every time your payment is made.
To see how much interest you’re charged per payment, you can view an amortization schedule and enter your car loan terms. Here’s a quick example:
Auto loan conditions:
Auto loan of $ 20,000 / Loan term of 60 months / Interest rate of 10% / Monthly payment of $ 424.94
- 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 reduce the amount you pay in interest charges. Because there is less interest accrued, more of your monthly payment is applied to your principal each month.
Plan your next car loan
Now that you know how your auto loan amortization works, you can plan your next auto loan with confidence. It is important to prepare for success and choose loan terms that benefit you.
While you may have a say in the terms of your loan, your credit score is a major factor in qualifying for vehicle financing and determining your interest rate. With a low credit score, you are more likely to qualify for a higher interest rate. If so, it is usually 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 negative equity risk. Negative equity is when you owe more on the car than it is worth. A higher interest rate can mean that more of your monthly payment is applied to interest each month, and less to your principal, which can make it difficult to reduce your loan balance quickly.
If you have bad credit and are worried about paying excessive interest charges, it is wise to choose a used vehicle. They are generally more affordable and you are more likely to qualify for a loan at a lower price.
Another way to reduce interest charges is to put more money on the loan. Saving a large down payment can take time, but reducing your loan amount means less interest charges can accrue.
If you have poor credit, a down payment requirement is usual. 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. The more cash you bring, the less interest charges accrue over the course of your loan.
Take the plunge into vehicle financing
Preparing for an auto loan is an important first step in financing a vehicle. However, with a lower credit score, it can be difficult to find a lender who can help you. There are, however, lenders ready to help borrowers with credit problems: subprime lenders.
These lenders look at more than your credit reports. Instead of relying solely on your credit history, they look at your income, overall stability, and require a down payment. They are registered with special finance dealers and we want to help you get in touch with one.
Here has Auto Express Credit, we have created a network of dealers who are registered with subprime lenders and have been helping borrowers find lending resources for over 20 years. Get started today by filling out our free auto loan application form. Using our network, we will search for a dealership in your area that has bad credit options. Take the leap into auto financing with us today, at no cost and with no obligation!