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How interest rates for car loans work

car loans

Acquiring a car is a status symbol these days. Whether you get one on credit, cash, or loan, there are certain rules that come into play. Choosing the right kind of payment method is very important if you want to keep the costs of automobile liability to a minimum. 

Payment methods by cash or credit are pretty self-explanatory however car loans tend to raise tons of questions. Understanding how car loans work goes a long way into individuating the pros and cons I love your course of action. 

There are three key factors that affect the interest rates on a car loan. If you plan on acquiring a car loan, take some time to do your research and find out the interest rates that are currently running in the market. It is common practice for institutions to change the loan interest rates on a daily basis for automobiles. Not just that, but they also tend to fluctuate drastically. 

Here are the key factors of interest on car loans:

  1. The interests calculated on a car loan are not compounded but construed as simple interest. Therefore, every month you keep paying a small sum of money as interest but the money paid towards interest does not yield further interest. So, the longer the period for your car loan payment, the more you keep paying. 
  2. Loans that are paid over a longer period of time tend to implement lower interest rates for your monthly payments. While it reduces your monthly liability to a certain extent, the overall amount that you pay towards the principal loan and interest is considerably higher than the estimated cost of the car. 
  3. Since, the interest paid on car loans is simple not compound, institutions and lenders tent levy higher interests if you wish to pay off the loans early. Based on these three factors, when choosing your preferred method of payment on an automobile purchase, start by checking the day’s running rates of interest. Follow that up with a transparent conversation with the lenders regarding the time period. Negotiate as small a time period as you can and aim to pay off your loan diligently but not too hurriedly. 

How car loans work? 
When you apply for a car loan, you are expected to put up at least 10% of the original cost of the car. Assuming that the cost of your car is $100,000, you contribute $10,000 as a down payment, and the auto loan lender pays $90,000.

Based on your rate of interest and the tenure of the loan, you will be charged a small amount to be paid on a monthly basis. Assuming the above financials, and the rate of interest of 5%, to be paid over five years, you end up paying a sum of $112,500. 

In this particular case, not only do you incur $22,500 in interest but also the total cost of the car becomes $122,500 instead of $100,000. Thus, you need a shorter time period with a smaller rate of interest. 

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