Understanding Your Monthly Car Payment | Luther Kia


Welcome to part two of our series about understanding car loans! (If you haven’t already, you can check out part one here.)


This week, we’re looking at interest and amortization. These two things make up the difference between paying off a loan and paying for a car completely in cash (and are what make the process a little confusing).


Interest Types

There are two different types of interest: simple interest and compound interest.


Simple interest is calculated on the total amount of your loan, while compound interest is more complicated and has to do with the accumulated interest and the principle (overall amount of the loan).


Luckily, most car loans use simple interest, which makes calculating loan payments much easier.


The thing to keep in mind about interest is that unless you are paying for a car in cash (which is rare for most people), you must factor interest costs into the total cost of your car. Just looking at a car’s sticker price doesn’t give you the whole picture of what you’ll be paying. Though loans differ from person to person because of down payments and what kind of rate you can get based on your credit history, it is very important to calculate interest when setting your budget.


Amortization

Most loans, including car loans, utilize a principle called “amortization.” This simply means that at the beginning of your loan period, a large portion of your payment goes towards your interest payment instead of towards the principal (or the money you borrowed).


As you begin to pay more and more of the loan off, the amount of your monthly payment that goes toward the principal increases. This is because as the amount you owe becomes less, so does the interest.


For this reason, it’s a great idea to make additional principal payments early on in the loan period. The faster you pay off the loan, the less interest you will end up paying.


One really easy way to do this is to round up your monthly payment. When your monthly payments are set, the number will likely not be a nice, even number. When setting up your recurring monthly loan payments online (which is recommended - automatically drafting the payment ensures you don’t miss it!), choose to make a slightly higher payment than what is required.


For example, if your monthly payment comes out to be $338.42, round it up to $350. That $11.58 every month adds up over time and can be an easy way to pay it off up to a few months faster, without ever making an “extra payment.” This additional bit will go straight towards the principal, instead of going towards interest. Chances are, you won’t miss a few extra dollars, but it can pay off big time when you end up paying off your loan sooner than expected!

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It’s important to do your research and take a look at your budget to determine what path you can and want to take when buying a new car. When the time comes to sit down and talk with a finance specialist, ask them plenty of questions and take the time to discuss your options so you drive away feeling good about your choice and your new purchase!
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