How Does a Simple Interest Car Loan Work?

A simple interest car loan means you only pay interest on the principal balance.

Simple interest financing is the most common setup for a car loan. According to Vertex 42, simple interest loans require "paying interest only the principal." With a car loan, you pay interest on the principal balance of the loan at the time of payment.

Basics

Car loans, like home loans, have payoff periods. Car loan terms commonly range from 36 to 72 months. Your original loan balance is what remains when you add the sales price, taxes, registration and other purchases fees and deduct any down payment.

Payments

Car loan payments are set up on an amortized schedule, similar to home loans. Your monthly payment includes principal and interest. The total payment is based on the assumption that if you pay the same amount each month for the loan term, you will reach a balance of zero. Initial payments have higher interest amounts, while later payments have lower interest amounts since the principal balance reduces over time. This is why you benefit from paying extra on principal each month.

Interest Formula

You can determine your total interest payments on a simple interest loan using the standard formula Interest (I) = Principal (P) times Rate Per Period (r) times Number of Periods (n). For instance, a $10,000 loan at a 7 percent interest rate paid over 60 months would cost $3,500 in total interest without any extra principal payments.

References

• Vertex 42: Simple Interest Formula and Calculator
• Rice University, Barbara Christopher: Calculating a Car Payment