When you decide to acquire a new car loan or refinance the current one, you agree to repay it over a specific period of time. Amortization is basically the process of paying your loan over a certain period of time. So, car loan amortization is where a certain percentage of your loan payments go towards the principal while the rest goes towards the interest and other related fees.
What is car loan amortization?
According to Lantern by SoFi, “When a loan follows an amortization schedule, the payments are divided between the principal owed and the finance charges.” The principal is the exact amount you borrowed from the lender and promised to pay back after a certain period of time. On the other hand, interest is the amount you are charged a fee for borrowing the loan. Your total loan balance comprises both the principal and interest. The monthly payments go towards clearing the total loan balance in the process known as amortization.
How does auto loan amortization work?
The interest obtained or gathered from an auto loan is regarded as simple interest. This implies that the amount of interest depends on the principal balance of the loan by the time it was calculated. Compound interest is the opposite of simple interest. Compound interest is accumulated from the total loan balance of both the principal and interest.
However, some lenders tend to calculate what’s commonly known as precomputed interest when a borrower takes a loan for the first time. In such a case, the total amount of your interest is gathered at the start of your loan term. This makes it difficult for the borrower to dodge or avoid paying interest. The lender will expect that a borrower pays the full amount of interest as agreed in the loan contract.
How does it work?
When it comes to amortization, most of the monthly payments go towards paying off the interest at the beginning of the loan term. This is the point where the principal amount is at its peak. As the principal balance starts to reduce, the amount being channeled towards interest goes down while the amount paid towards the principal increases.
What is an amortization schedule?
If you are wondering how much of your monthly payments go towards the principal and interest, then the best way to understand is by creating an amortization schedule. The schedule offers a roadmap on how the payments will be distributed between principal and interest. You can use online calculators to assist you in approximating your amortization schedule.
Factors that affect your auto loan amortization schedule
1. Down payment
It is possible to lower the amount of interest charged on the loan by increasing the amount of the down payment.
2. Your loan’s interest
If the interest rate charged is high, then it means that you will also pay higher interest on the loan.
3. Duration of the loan
Increasing the duration of your loan will automatically raise the amount of interest on the auto loan.
In a nutshell, understanding your car loan amortization schedule will give you an idea of how much interest you are paying over a certain period.