How Car Loan Interest Works (The Truth)

If you don't understand how the interest works on your car loan then you're always going to spend way more money than you need to and that's not something to be proud of. I get a lot of questions asking how car interest works so in this video I'm going to cover the basics so that you guys can at least understand how the math works and then what I really want you to do is just pass it on to somebody else so that they can learn the same information that I'm going to pass on to you. I made a car interest video on this channel a while back but I really just wanted to give it an update and that's why I'm making this one so that I can hone in on the basics and so that you guys can learn something new and pass it on to someone else like I said earlier. Now if you just found this channel I'm Jason with Honest Finance and I make a lot of videos on different topics that'll give your life and your finances more value so definitely subscribe if you're into that type of content but for now let's just start talking about car loan interest. So I'll start by saying that car loan interest works the exact same way as an installment loan with a fixed rate because that's exactly what a car loan is. It's just a loan where you set the contract to a certain amount of time and the interest rate and then you just pay monthly until the loan's paid off and that's it. So if you've got a conventional mortgage or a personal loan those all work pretty much the exact same way too and as long as the loans are the same the math is always going to be really easy to do because once you understand how to do it you can do it on every single type of these loans as long as they're the same type of loan. Just make sure that your loan always has a fixed rate and not a variable one because a fixed rate loan is always going to stay the same and your monthly payment is going to stay the same but if you have a variable rate that can actually change your monthly payment and that is not cool because the last thing you want to have happen is to be used to a $400 a month payment and then all of a sudden it goes up to $450 because your rate changed because you're on a stupid variable rate because that is not a good thing to do. So the first car I bought when I was 20 years old actually had a variable rate of about 16 to 18 percent interest and then I paid every single fee that the dealer had because I was so ignorant when I was buying the car and now I'm just going to teach you guys everything that I know so that you don't make the same mistakes that I did. Car loan interest can cost you way too much or it can actually be fair and that's all dependent on just how you set up the loan. Now with just some basic research I found that the average new car loan is actually for about $30,000 and then for a used one it's about $20,000 but in my opinion that's way too expensive because you're counting everyone in the entire country and that is just a really high car loan and then the average interest rate is about seven and the average term is about 65 months which is really long and when you end up doing all the math for your car loan interest those are the three numbers that you're going to need. You're going to need the amount of the loan, the interest rate, and then how long you're paying it back which is the term. Now right now I'll teach you how to do the basic math so that you can get a rough estimate of how much you're paying on interest right now on your loan and then I'll go over the fancier stuff with the real math. So let's pretend that you have a car loan for $25,000 with an interest rate of seven percent and you want to know how much interest you're actually paying on it right this very second. All you have to do here is put in $25,000 in your calculator and then times it by seven percent which is point zero seven in your calculator. Now you're going to end up with $1,750 which is $1,750 that you're paying in interest per year on the amount that you owe right now which is based off of $25,000 and then if you want to figure out how much interest you're paying per month just take $1,750 and divide it by 12 which is going to end up being $146 per month that you're paying in interest right now on that loan. Now that's just a quick way to figure out how much interest you're paying right now but it's not a hundred percent accurate because you've got to understand that as you make monthly payments some of your money is going towards the principal or the balance and then some of the money is also going towards interest as well. So as you make your payments every month and some of that money goes towards your principal you're going to owe less which means you're actually going to pay less in interest because of it and if you can make extra payments towards your balance every month I would definitely do that because in the long run you're going to end up paying off your loan faster and you're going to pay less in interest which is just a win-win all because you're paying extra on your loan. Just make sure that the money you're using for your extra payments is actually going towards the principal because there's a lot of lenders out there that will just stick the money in a cash account if you don't specify it with them which I think is super dirty but they do do that so watch out for it. And then some lenders will only let you make an extra payment if it's for the exact same amount or more as your monthly payment already is. So for example if it's 375 bucks a month then in order to do an extra payment you're going to have to come up with at least 375 bucks in order for it to qualify with them which I think is super dirty but oh well that's the way that some lenders do it. I've had a couple loans that do this and it is a little bit annoying but what I've ended up doing is just saving up my extra payments until I have enough to qualify for it and then I just put it towards the loan and that's the end of it and I do it again. And now I'm going to teach you guys how to do the real math but you are going to have to have what's called a loan calculator but you can find this on any app store or you can just google loan calculator and you'll find one. It doesn't really matter which one you use because they all do the exact same thing so just find one that you think looks decent and use that. Now right here we're going to be messing with what's called the amateurization schedule which is basically just the math side of your loan and I can't do this without a loan calculator so I always need to do this and I can't do it on paper because I'm not that smart but this is how we're going to do it and I'm going to show you how to do it on my phone. Okay so this app is called Loan Calculator Professional and I like it because you can do extra payment math on it but I'm sure that others can too. Now all you do is plug in your loan amount which I'll set to $25,000. Then just set the interest rate which I'll put at the average which was seven percent and then I'll set it for five years which is 60 months because there's no such thing as a 65 month car loan. Now just make sure that you're set to monthly payments and then we won't do any extra payments for this example. Hit the calculate button and you can see right here that we're going to be paying $495 a month for the next five years and we'll pay $4,700 in interest over the life of the loan. Now we'll click on the schedule and you can see exactly what you'll pay in interest by the month. You can see right here that your first month is going to be about 146 bucks in interest but if you scroll down you're going to see that your interest is going to go down a little bit every single month because remember that as you pay down your loan you're going to pay less in interest because you're only going to be paying on what you currently owe and that's all there is to it. So just make sure that you make your monthly payments for your car every single month because as you pay down the loan you're going to pay less in interest and that's just how the math works. Now go ahead and plug a bunch of different scenarios into the loan calculator so that you can see all the different prices and the terms based on what you set so that you can see what you can actually afford. And just remember that you can use this loan calculator on all your different installment loans as long as they're a fixed rate because as long as they're fixed then you're good to go and you can do the same math on all your different loans. And then if you do make extra payments on your loan your schedule is going to change but it's going to be in a good way because remember you're always going to pay off your loan faster and pay less in interest when you're paying extra. And in my opinion I think the easiest way to pay extra on your cars is just to round up your monthly payment because you're probably not even going to notice that in your budget. So if you have a car payment of 475 bucks a month then I would just round it up to 500 bucks a month that way you're at least paying something extra on the car and it's not really going to kill your budget but at least you're starting to pay a little bit extra. And then on top of that if you can set your automatic payments to 500 bucks a month that way you never have to worry about it and you're always just going to be paying extra which is super easy to do. Now if I'm making sense with this video can you please just hit the like button below to let me know that I'm actually making sense of what I'm trying to do because I really just want you guys to get what I'm talking about and that is all. Thank you very much. Okay so I've talked about this in a lot of my other car videos and it's simply the fact that way too many people only care about their monthly payment and this is a very bad mindset to have because it's not the right math that you need to be paying attention to. Obviously at the end of the day your car payment does matter because you can only afford so much car but what you've got to understand is that the and this can either be a good thing or a bad thing on the math side. So if I were a car salesman and you told me that you couldn't afford the monthly payment then all I would have to do is just extend the loan and make it longer and then your monthly payment would go down but that's actually ripping you off more even though you're getting a better payment. Because naturally when you make the loan longer you are going to have lower payments which might sound like a good thing but the problem is is that you're going to pay way more in interest on the car and then on top of that you've got to understand that cars are depreciating assets and if you're not paying them down fast enough you're actually going to end up upside down in the loan which is a very bad thing. So when you're upside down in your car loan it means that you owe more than the car's actually worth and this is really bad because if you try to go sell your car you're actually going to have negative equity in it and you're going to have to start your new loan with even more debt and that's just a problem that's going to keep going and going until you solve it and stop it. So watch what happens right here when I extend the length of the loan from the example that we were using earlier. We had a $475 payment on a $25,000 loan that was set for 60 months at 7% interest but if you change the term to 84 months your payment is going to go down to $377 a month but guess how much you're going to pay in interest over the life of the loan? You're going to end up paying about $6,700 in interest which is just a total waste of money that you end up giving to the bank just because you wanted a lower monthly payment and that is not something that's good or to be proud of. I only recommend that you go up to five years at the absolute most on your car loan and if you can help it I would stick between two and three years because that's going to get it paid off the fastest and you're going to pay the least amount of interest but of course you can always pay cash and that's going to save you the most overall. Now if your credit isn't very good or you're a first-time borrower then there's a really high probability that you're going to get a terrible interest rate and that is not something that I think that you should take on as far as a car loan goes. I get a lot of comments on the channel where guys are actually telling me that they have interest rates of about 20% because that's what the dealer set them up with because of their credit situation but the truth is is that if you get a rate that's that bad I would actually recommend that you just save up for the car and pay cash or that you try to get a cosigner for it because that's going to help you out in the end because those rates are just way too high. You need to understand that if you have a loan for $25,000 at 5% but your interest rate is 20% then you're actually going to be paying about $15,000 in interest over the life of the loan and that is just way too much money for those types of interest rates. And the worst part about it is that that's only based on 60 months so if you actually had a 72 or an 84 month loan at 20% interest then you're going to pay even more which is just so terrible. And don't just go with the first rate that you're given especially at the dealership because they can actually take a cut of the loan and that is not in your best interest because it's just a waste of money. So if you're Or if you want a direct recommendation from me then I'd recommend going with Lightstream Auto Loans because they have very good rates and terms and they don't care about the make, the model, or the year of the car which is really cool. I'll leave an affiliate link in the description below which means I may be compensated if you click through it but just keep in mind that I'm never going to recommend a company to you guys that I don't think is going to give you guys the best value and in my opinion I think that Lightstream is really good. Now once again I'm Jason with Honest Finance and I make a lot of videos on different topics that'll give your life and your finances more value so definitely subscribe if you guys are into that type of content. But for now if you guys want to learn more about Lightstream or other car related videos I'm going to link some up over here but that's all for now.