When you take out a car loan, whether it be a new car, used car, or refinancing an existing loan, you make payments each month on both principal and interest. While this seems like an easy concept to most people, it isn’t quite as simple as it sounds.
As your auto loan progresses you will pay a different amount towards principal and interest each month even though the total payment amount remains the same.
This is a process known as car loan amortization. Understanding car loan amortization, how it works, and factors that can affect your amortization can help consumers save money and pay off a loan faster.
What is Car Loan Amortization?
Car amortization is the process by which you pay down both the principal and interest on a loan. The amortization decided how much of each monthly payment will be directed to the principal balance and how much will be directed to interest accrued.
How Does Car Loan Amortization Work?
The majority of car loans are known as simple interest loans. A simple interest loan only accrues interest on the remaining principal balance. Therefore, as your term or amortization progresses more of your payment goes towards the principal, and less goes towards interest.
For this reason, simple interest amortized loans are known as “front-loaded” because the majority of the interest is paid in the “front” or beginning of the loan. Tracking how your payment is split between interest and principal can be accurately calculated using an amortization schedule.
What is an Amortization Schedule?
But what exactly is an amortization schedule? An amortization schedule will break down exactly how much of your payment goes towards interest and how much goes towards the principal. These schedules are usually laid out as a table for easy reference. Amortization schedules can be structured in one of two ways, yearly or monthly.
A monthly representation will show how each payment is split month over month. A yearly schedule however will give consumers the total amount paid towards interest and principal for the entire year. Both representations can be helpful and help buyers understand how to pay off a vehicle earlier.
Factors That Affect Your Car Loan Amortization Schedule
A number of factors can affect your car loan amortization schedule. According to Lantern by SoFi, there are five key factors that can affect an amortization schedule. Loan term, down payment, interest rate, fees and taxes, and trade-in value are all crucial in determining (or shortening) an amortization schedule. Working closely with a lender will help buyers understand which areas make the most sense to tweak to save the most money.
Car loan amortization may not be a highly discussed topic. While amortization may sound complicated or too technical, it is a relatively simple concept once understood. Understanding car loan amortization can lead to a consumer saving hundreds if not thousands on their car loan. So check out the car amortization next time you are shopping for a car loan.