You may have started researching financing options if you are in the market for a new car. Auto loans are readily available through traditional banks, credit unions and online lenders, but they’re not all the same. Beyond the varying loan terms each lender offers, you’ll also need to consider how they assess interest on auto loan products.

Simple interest auto loans are common and come with several benefits that make them an attractive option. You can save more money by paying them off early than you can with a precomputed interest auto loan.

How a simple interest auto loan works

Simple interest auto loans come with a fixed monthly payment. However, the amount applied to interest each month is based on the outstanding principal balance.

More of the monthly payment is applied towards the interest on the account when you initially take out a simple interest auto loan. However, as you pay down the loan, you’ll notice that a larger portion of the monthly payment starts to go toward the principal. The amount the lender charges in interest decreases as the outstanding loan balance goes down.

Here’s an example of how simple interest auto loans work.

Assume you get approved for using a four-year $36,000 auto loan with an interest rate of 6 percent. You’ll pay $845.46 monthly and $4,582.13 in interest over the life of the loan.

This table demonstrates that the further you are into the loan’s life, the more your monthly payment will go towards paying down the principal rather than interest.

Month Interest paid Principal paid Remaining balance
1 $180 $665.46 $35,335.54
12 $142.47 $702.99 $27,791.17
24 $99.11 $746.35 $19,076.03
36 $53.08 $792.38 $9,823.36
48 $4.21 $841.25 0

Use Bankrate’s auto loan calculator to compute your total interest costs on your next auto loan.

How it differs from a precomputed interest auto loan

If you take out a precomputed interest auto loan, the lender calculates the interest you’ll pay over the loan term. It’s added to the principal loan amount and divided evenly to generate the monthly payment figure.

So, repaying the loan before the term ends won’t save you money since interest is already factored into the amount you owe when you take out the loan.

Simple interest auto loan benefits

Simple interest auto loans come with a few key advantages that make them a popular option:

  • More affordable payments: Since the amount of interest you pay each month is only based on the principal balance, you’ll get lower monthly payments than you would with a compound or precomputed interest loan.
  • Sizable cost savings: If you decide to pay the loan off early, you could save a bundle in interest.  For example, if you take out a five-year, $25,000 auto loan with a 5 percent interest rate, the monthly payment will be $471.78. Plus, you’ll pay $3,306.87 in interest over the loan term. But if you pay an extra $100 each month, you’ll pay the loan off in 49 months and save $651.04 in interest.

How to save on a simple interest auto loan

Use these strategies to save money on a simple interest auto loan:

  • Pay more than the minimum: Paying extra each month or even doubling up on the payments can help you reduce the principal balance faster and pay off the loan early. But before using this strategy, confirm that the lender doesn’t assess prepayment penalties.
  • Make timely payments: If you fall behind on loan payments, you could be charged late fees and accrue additional interest on your simple interest auto loan.
  • Sign up for autopay: Doing so prevents you from having to worry about missed payments, unnecessary fees or adverse credit reporting, which could be costly over time.

Next steps

Simple interest auto loans are a viable financing option for your next new ride. You will enjoy a fixed monthly payment and the ability to save a bundle in interest if you can pay your loan off early.

When you’re ready to move forward, shop around to find reputable lenders that offer simple interest auto loans. And make sure to prequalify with at least three lenders before signing on with one.

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