Is a Simple Interest Auto Loan a Good Way To Save Money?
A simple-interest car loan is a common way to borrow money to buy a car. What’s great about simple-interest auto loans is that you can save money with this loan structure when you’re buying a vehicle.
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Simple vs. Compound Interest
Simple-interest car loans calculate interest based only on the original amount, called the principal, you borrow. On the other hand, compound-interest loans charge you interest on the principal and also on any unpaid interest. With simple-interest loans, you pay a fixed interest rate, while compound-interest rates can be variable.
Since you are being charged interest on a larger amount (the principal and unpaid interest) on a compound loan, this can cost you hundreds of dollars more over the life of the loan than a simple-interest auto loan. Additionally, if your compound interest rate increases, this will increase how much you pay for your car.
Pro Tip: A good credit score will help you get a lower interest rate on your car loan, which can save you hundreds.
How To Calculate a Simple-Interest Loan
To calculate the interest payment for a simple-interest auto loan, your lender multiplies the amount you borrowed (P) by the interest rate (i) by the term (n) of the loan.
The calculation for simple interest is therefore: Simple interest = P x i x n
For example, if you borrow $25,000 with a 6% interest rate over four years, your estimated monthly payment would be around $587. Over the loan period, you would pay a total of about $3,182 in interest.
How To Save Money with a Simple-Interest Loan
You can reduce the total interest you pay by making larger than minimum payments each month. At the beginning, a larger percentage of your monthly payment goes towards interest than goes towards principal. The more payments you make, the larger the percentage of each payment is going towards your principal.
Since simple-interest loans are calculated solely off principal, reducing your principal amount as quickly as possible will help you save money on your loan. You can reduce your principal amount by making extra payments, paying more than the minimum each month, or paying off your loan early.
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Basically, the faster you can pay off your loan, the more money you will save.
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This article originally appeared on GOBankingRates.com: Is a Simple Interest Auto Loan a Good Way To Save Money?
