No products in the cart.
If you’re reviewing several options for an auto loan, you may notice they differ by their interest/principal payment options. Which in many cases, leaves one wondering: Is it better to pay principal or interest on a car loan? The short answer is: Principal. But keep reading to understand why – and see if this is also the best option in your particular case.
The principal is the amount of the loan, the actual purchase price of the car, while interest is an expense to you and income to the bank or financing company. It is the cost of borrowing. Being able to pay less interest over the life of the car note is how you can save money on the car, in addition to having a lower purchase price in the first place.
However, car loans are virtually unavoidable given that most Americans need to drive and don’t have the cash to buy a vehicle upfront. Simultaneously, the average price of a new car has risen 2.3% from 2018 to 2019, according to Experian. In the first quarter of 2019, Americans paid an average of $554 per month for a new car and the average car payment for used cars was payday loans CA $391. In comparison, the average lease payment is $457 per month for the same timeframe.
A car loan is typically five years, or 60 months although some banks offer two and three-year financing options depending on factors like the size of your down payment, your creditworthiness, and income. Subprime car loan terms for borrowers with fair or poor credit can be longer, around 72 months or six years.
The best possible scenario is paying down your car loan as soon as possible so that you can own it outright and also pay less interest in the long run. To better understand your car loan and how interest and principal work, you’ll want to bear the following in mind if one of your goals is to pay off your car loan early.
Whether you’re taking out a car loan or a mortgage, a significant portion of your first year or two of payments is going to be allocated to interest, and there are a few reasons for this. Whether you have excellent credit or not, so much of the first few payments goes to interest so that in the event you default on the loan, the lender has a more favorable profit if they repossess the car before it depreciates too much. While the same concept of higher interest payments in the early years also applies to mortgages even though homes can appreciate in value significantly, the term of the car note is much shorter than a mortgage which is likely to be a 10, 15, or 30-year commitment.
The shorter the life of the car loan, the higher the interest even if you have good credit. The lender wants to make money off the loan and unlike real estate, cars don’t have a long life and they also lose value over time.
When you borrow money with a fixed periodic interest rate like a home mortgage, car loan, or business loan, the lender creates an amortization schedule that details exactly how much of each payment will be allocated to principal and interest. If you use a loan calculator or spreadsheet to determine how much you are able to afford for a car payment, you can visualize an amortization table detailing how much you pay in interest and principal every month even though your car payment amount does not actually change.