A simple interest car loan is a type of loan that uses your loan principal and daily interest rate to determine how much you owe on the loan.
The formula for simple interest calculation is: Outstanding Principal Balance x Daily Interest Rate
Let’s break down the parts of this equation.
- Outstanding principal balance is how much money is borrowed towards the purchase price of the vehicle. This is not inclusive of any interest charges or fees.
- Daily interest rate is simply your annual interest rate divided by 365.
It provides flexible payment options and often has a lower rate than a conventional auto loan, making it an appealing financial option for many people.
The lender typically requires the borrower to pay a certain amount each month based on the principal balance and the interest charged, which is determined by the loan’s duration and annual percentage rate (APR). With simple interest car loans, borrowers benefit from having the same monthly payment and can generally prepare better for their long-term financial decisions. For added convenience, many lenders offer automatic payments to ensure timely customer payments are made.
Simple Interest Payment Schedule Example
Here is an example of what a payment schedule would look like if you were to get approved for a 48-month simple interest car loan of $15,000 with a 5% rate.
|Paid to Principal
|Paid to Interest
|Total Interest Paid
Simple Interest vs. Precomputed Interest Car Loans
If a loan is taken out for a vehicle, it’s typically either a simple interest or precomputed interest loan. Both loan types are based on the purchase price of the vehicle, minus any down payment or trade in vehicle credit, and then considers factors like credit, income, and employment to determine your approval and rates.
In a loan with precomputed interest, the total interest owed is calculated upfront and then dispersed into payments throughout the loan term.
The difference here really comes into play in how you make your payments. This is because with a simple interest loan, the way you handle your payments can actually impact the amount you owe in interest, where in a precomputed interest loan it cannot.
Making Payments on a Simple Interest Auto Loan
With interest accruing daily on simple interest car loans, the timing and amount of your payments can make a big difference in the total interest you pay over the life of the loan.
When you make a payment on a car loan, the funds first cover any fees and interest. Then, whatever amount is remaining goes towards paying down the principal amount of the loan.
Paying Early or Extra
Paying early or paying more means that there’s more that goes directly towards your loan principal rather than going towards covering interest. Being that your interest is calculated in part based on the remaining principal, your interest charges will be less if your principal balance is lower.
In the long run, this could save you money overall on the loan by reducing the total interest paid.
Paying late or missing payments for your simple interest car loan, on the other hand, can be very costly, not to mention it can hurt your credit score.
For the same reasons that early payments can save you money, late payments can end up costing you more. This would cause interest to continue to accrue on a higher balance for longer.