How do auto loans work?
If you’re in the market for a car but don’t have the necessary cash on hand to make the purchase, then you are likely looking at getting an auto loan. Auto loans are usually simple interest loans, which means that the interest on the loan is determined based only on the principal balance of the loan.
For example, a $15,000 car loan with an interest rate of 3% and a 5-year loan term would have a monthly payment of $270. Each month, your monthly payment will go towards paying off the interest that accrued on the principal balance and the rest would go towards paying off the principal. As the principal amount of the loan decreases so will the amount of interest paid each month. Since the balance is higher when you first start to repay the loan, in the beginning, more of your monthly payment will go towards paying the interest.
Continuing with our example, of that first $270 payment, $37.50 will go towards interest. However, when the loan balance is $10,000, only $25.00 of your monthly payment will go towards interest.
While understanding how interest is calculated on an auto loan is essential, there are a lot of different factors that go into auto loans and deciding which car loan might be best for you. These include the loan amount, the interest rate, the loan term, the total cost of the loan, the monthly payment you can afford, and how much you’re borrowing based on your down payment.