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Car Finance 101: How Does the Car Loan Interest Affect How Much You Pay for Your Car

By August 26, 2019 No Comments

So you are planning to buy a car through car finance. How does this work? You get a car loan to buy a car, the lender will purchase the car for you and you need to pay it back over a period of years. You will be paying for the lender’s services through interest.

Generally, car loans use simple interest which is a type of interest in which the interest charge is calculated based only on the principal. Simple interest does not compound on interest, which saves the borrower money.

Simple interest does not mean that you would pay equal amounts of interest and principal throughout the duration of your loan. Normally, car loans will be paid via amortization. This means you will pay more interest at the beginning of your car loan than at the end.

All About Car Finance Interest Rate

Does the Length of Your Car Loan Affect Your Interest Charges?

The car finance interest rate is not the only factor that affects the total amount of interest charge that you need to pay for your car loan. So, yes, the length of your car loan affects your interest charge. The longer your term length, the more your cumulative interest charge will be. 

For example, you bought a $12,000 car with a car loan that requires you to a 10% interest rate. You were given a choice between a four-year loan and the five-year loan. The 4-year loan would require monthly payments of $304.35 while the 5-year loan would require the $254.96 payments. If you are going to look at the amount of monthly payment, the 5-year loan may sound more tempting since it saves you money every month. 

You are not wrong for thinking that you are saving money on a monthly basis, however, you also need to consider the effect the extra 12 months will have on the interest charges you pay over the course of the loan. Simply put, the longer you owe money on your car, the more interest you need to pay.

Is it Possible to Reduce Interest Charges?

Yes, it is possible to reduce your interest charges. You can reduce your interest charges by making early and unscheduled payments. Doing so will bring down your loan balance and because your interest charges every month is based on how much you still owe on your loan, your interest charges will go down along with your balance.

In the case that it is not possible for you to pay extra each month for your car loan, but still would like to reduce the payment for your car, you may want to consider refinancing your car. You can refinance to a lower interest rate which means that you may pay significantly less for your car loan in the long-run.

How to Use the Car Finance Calculator?

Since there are a lot of factors that affect the equation, it would make more sense to make use of a Car Finance Calculator to find out how much would your monthly payment be rather than to compute over and over again. Using a car loan calculator is easy, just follow these steps. 

  1. Enter your total loan amount in the calculator. If you are not sure how much your loan would be, then just enter the amount that you think will be sufficient to finance your car.
  2. Enter your purchase rate. You can make use of the comparison rate of the car loan to be able to determine your repayments more accurately.
  3. Enter the duration of your loan or your loan term. Keep in mind that the shorter the term the more your repayments will be, but the more you will save on interest.
  4. Set the frequency of your repayment. You need to check your options as not all lenders will offer every type of repayment frequency. Choose the frequency that you are comfortable with.
  5. Choose the type of repayment you prefer. There are different kinds of repayment.
    1. Principal and interest repayments – repayments that go towards both the amount you borrow and the interest charged on that amount.
    2.  Interest-only repayments – paying the interest which is charged on the loan amount. This means that you do not actually pay any of your loans off. 

If you are not sure, you should select the principal and interest option.

What Do You Need to Consider Before Apply for a Car Loan?

The car finance calculator may help in taking a burden off your shoulders by figuring out what your potential repayments are going to be. However, you need to keep in mind that it is also important to factor in the following so you can make a decision whether the car loan you have chosen is right for you and your needs. These factors include the following:

  • Loan terms – The car loan term varies from one lender to another, but most car loans are for one to seven years. The calculated car loan repayments that you can afford will determine your loan term. But keep in mind that you can always lower your repayments by selecting longer loan terms. This can be a good option if the loan also gives you the ability to repay it ahead of schedule if you can.
  • New car or used car – Like most things in life, both new cars and used cars have their own pros and cons. The kind of car you are buying can actually impact which car loan you are eligible for. Since it is different for each lender, some may want to supply loans for new cars only and others supply loans for new or used. 
  • You ability to get additional funds – There are some lenders who can allow you to borrow additional funds within the loan to cover other expenses such as registration and comprehensive car insurance. But keep in mind that this is not always the case. 

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