Dear Dr. Don,
Is it wise for me to pay off my simple interest car loan early? I want to pay it off, but the company is telling me that my balance is the same whether I pay it now or pay it over the next 17 months. This makes no sense.
-- Jane Jalopy
It's more likely that you have a simple add-on interest auto loan versus a simple interest loan. An add-on loan adds the interest expense to the amount borrowed and spreads those payments over the loan term. You can't reduce the interest expense by paying the loan off early because the total interest expense is included in the loan balance.
A simple add-on interest auto loan charges interest as if the initial money borrowed is outstanding for the entire loan period. That effectively doubles your interest expense, because you are paying down the loan proceeds over the life of the loan, making the average money borrowed over the loan term one-half the initial loan amount.
If a simple add-on interest auto loan does allow you to pay the loan off early, there is often a prepayment penalty that reduces the interest savings or the interest rebate is determined using the Rule of 78s that frontloads the interest expense over the life of the loan.
Because the lender is telling you there's no benefit to paying the loan off early, it sounds like your loan isn't structured to provide you with any interest savings by prepaying the loan. Still, it would be worth reviewing your loan documents to confirm that there is no interest rebate if you pay the loan off early. Refinancing won't help because you're already committed to paying the interest expense on the existing loan.
Bankrate's auto loan calculator calculates the monthly payments on a simple interest loan and shows the amortization of that loan over the loan term. If the lender's numbers don't match Bankrate's, they need to explain why. Odds are it's a method of interest calculation that benefits the lender, not the borrower.
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