Buying a car is one of the more expensive purchases you will make in your lifetime, so you will most likely need to take out a loan to do it. Interest rates will have a huge impact on the total cost of your car, however, so it is very important to understand how to calculate your auto loan to understand the impact that interest has on your loan. Just a single percentage point difference in interest can cost or save you hundreds of dollars and even paying just a few dollars more per month on your loan can also rack up some real savings over time. Here are 3 tips on how to calculate your auto loan and how to save money doing it.
Use a calculator
When calculating interest rates, you always want to use an interest rate calculator. This is because interest compounds over time. That means that every day, month, week or year the interest is calculated and added onto the principal. Most auto loans are compounded monthly, which means every month the interest is totaled and added to the principal, raising the total of the loan. This also means the amount of interest you will pay every month will be different. At the start of your loan, your interest payments will be much higher than at the end of your loan. For instance, if you take out a $20,000 loan for 5 years with an annual interest rate of 5%, then the first year you will pay roughly $600 in interest. In the last year, when you owe roughly $1,500 of the loan amount, you will only pay around $15 in interest.
The more often you make payments, the less you will pay on the loan
If possible, you are better off making half a payment every two weeks rather than a full payment each month. There are two reasons this helps you. First off, every time you make a payment, you are decreasing the amount you owe. Because of compounded interest, every day adds a dollar or two to the total amount of your loan. Every time you make a payment, you are decreasing the principal amount that you owe, which is the amount that gets compounded every day. In addition, there are only 12 months in the year, but there are 52 weeks. If you make a payment every 2 weeks, then over the course of a year you will be making 26 half payments or 13 full payments. Paying a half payment every other week allows you to make one extra full payment each year.
The more you put towards the principal, the less you will pay in interest
Every time you make a payment, the first thing that comes out of it is a payment towards the interest. When you first start paying on your loan, you may be paying as much or more towards the interest than you are towards the principal. Anything you pay over and above the amount of your payment, however, all goes straight towards decreasing the principal. If you make even a $20 additional payment each month, that adds up to paying off an extra $240 in principal per year. Remember, the lower your principal balance is, the less you will pay in interest. The less of your payment that is going towards your interest each month, the more of it that is going towards paying off the principal. On a 5-year loan, that could potentially decrease the life of your loan by almost a full year and save you hundreds of dollars in interest.