How to Understand Simple-Interest Car Financing
Most car buyers are focused on brands, models, features and pricing, and those are certainly important decisions. But it pays to understand the details of your auto financing, too. This will allow you to calculate exactly what fits your budget.
A good place to start is to understand how simple-interest car financing works. When you understand the basics, you can use the Credit Acceptance Payment Calculator to easily simulate a budget for a car payment. The next step is to get pre-qualified with Credit Acceptance and enter any dealership with confidence knowing that you already have financing in place.
First, let's explore the concept of simple interest.
How Simple Interest Works
When you obtain auto financing, the bank or finance company provides you with the money to buy a car and allows you to pay it back through monthly payments over a defined period. You are charged interest to compensate the lender for allowing you to borrow the money. Here are some terms to understand:
- Down Payment. This is the amount of money you spend on a car without borrowing. If the car costs $23,000 and you make a $3,000 down payment, you have $20,000 left to be financed (aside from any taxes, fees or other costs).
- Principal. This is the amount of money you borrow. In the example above, the principal would be $20,000. You would go to a bank or a financing company and borrow that amount to buy the car.
- Interest Rate. The lender charges you interest for borrowing the money, and the interest rate can vary according to many different factors. For example, if the interest rate is 10%, you'll pay 10% of the loan amount as interest every year (because this is just an example, your actual rate could be higher or lower). On a $20,000 loan, 10% interest is $2,000.
- Term. You agree to pay back the money over a certain period, such as 3 years or 5 years. This is known as the term.
Most auto financing involves simple interest, which is interest calculated only on the unpaid principal. This means the faster you repay the principal balance, for example by paying more than the standard monthly payment, the less money you will pay out in interest. In our example, if you paid the car off a year early, it would reduce the total interest to $2,000 and the total cost to $25,000.
Factors that Lower Your Interest
A few key factors that can influence the amount of interest you pay, include:
- Credit Score. Generally, the higher your credit score, the lower the interest rate you will have to pay on financing.
- Down Payment. The more money you have for a down payment, the less you will have to borrow, which means you will pay less interest.
- Term of Loan. The longer the loan term, the more interest you will pay.
Improving your credit, saving for a down payment and knowing how your financing works can make a big difference in how much interest you pay. To learn how much you can borrow and what interest rate you qualify for before you walk into a dealership, get pre-qualified for financing with Credit Acceptance.
