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Financing car purchases has become the norm in America. Over 85% of new car purchases are currently getting financed, and even about 62% of used vehicle sales are now being financed through auto loans, too.
If you’re currently hoping to secure a loan to fund your purchase, then it’s important for you to understand that different providers offer different types of loans. It’s up to you to do some research to ensure that you opt for an auto loan with favorable terms that work for you.
One major question you may have is – what’s the difference between simple interest auto loans and precomputed interest car loans? Learn more about the differences between these two as well as the advantages and disadvantages of both below.
What is a Simple Interest Auto Loan?
The first type of loan we will go over is a simple interest auto loan, which is also the most common type of auto loan taken out by consumers. So, what is a simple interest loan? In a nutshell, this type of financing works by charging interest on your existing loan balance daily. In other words, the amount of interest you pay will depend on how large your total existing auto loan balance is when the interest is levied.
You can get a simple interest auto loan through direct/indirect auto loan financing. Direct loans stem from a credit union or bank, whereas indirect loans come from car dealerships themselves.
How Do Simple Interest Auto Loans Work?
As you pay monthly on simple interest auto loans, a big chunk of it will go directly towards interest. Some of it will go to paying off your principal loan amount. As you pay off more of your loan, you’ll pay less in interest and more towards the principal.
If you pay more than the minimum amount due on your loan, then you’ll pay more towards the principal. That means you’ll pay less overall in the long run.
One of the biggest advantages of this type of loan is that you’ll likely have lower overall monthly payments than if you go with a precomputed interest loan. Even better, paying off your loan early will save you a lot of money in the long run. It’s also easier to calculate your expected payments.
There are some disadvantages to simple auto loans. For one, many of these loan arrangements involve a high interest rate, which means you’ll be paying way more than the actual value of the car in the long run. Another downside is that if you do wind up missing a payment later, then you could incur late fees and penalties that cause you to pay even more.
What is a Precomputed Interest Auto Loan?
Another auto loan option available to you is a precomputed interest auto loan. So, what is a precomputed interest loan? With these loans, the interest payment amount is calculated upfront instead of as you pay your balance. In other words, the interest payments will remain steady throughout your loan payments instead of starting out big and then getting smaller over time.
How Do Precomputed Interest Car Loans Work?
In general, your auto lender will calculate how much you’d pay in interest payments if you were to make the minimum payment monthly for the duration of the loan. Then, they simply add that amount to the principal balance of your loan. This amount is then split up evenly, and you will make your monthly payments as usual.
The biggest benefit of this type of loan is that prequalification on auto loans is easier than when compared to a simple interest rate loan. You can usually borrow even if you have poor credit. If you don’t qualify for a simple interest loan, then consider applying for a precomputed interest auto loan.
When interest is precomputed for secured/unsecured auto loans, you usually don’t get as much of a financial benefit from paying off your loan early. That means you save less money than you would with a simple interest loan. What’s more, you’ll likely face higher monthly payments.
Simple VS Precomputed Interest: The Bottom Line
The loan that’s best for you depends on your financial situation. If you have a poor credit score, then a precomputed interest car loan might be your best bet. If you’re hoping to save money, though, then you’ll want to go for a simple interest loan.
Let’s look at an example of both types of auto loans and how they would work:
Simple interest loan Precomputed Interest
| Type of Loan | Principal | Interest |
|---|---|---|
| Simple Interest Loan | $5,000 | 20% |
| Precomputed Interest Loan | $5,000 | 20% |
| Month | Interest | Principal | Simple Interest Monthly Payment | Precomputed Interest Monthly Due |
|---|---|---|---|---|
| 1 | $85 | $417 | $502 | $500 |
| 2 | $70 | $417 | $487 | $500 |
| 3 | $68 | $417 | $485 | $500 |
| 4 | $62 | $417 | $479 | $500 |
| 5 | $55 | $417 | $472 | $500 |
| 6 | $48 | $417 | $465 | $500 |
| 7 | $41 | $417 | $458 | $500 |
| 8 | $34 | $417 | $451 | $500 |
| 9 | $27 | $417 | $444 | $500 |
| 10 | $21 | $417 | $438 | $500 |
| 11 | $13 | $417 | $430 | $500 |
| 12 | $7 | $413 | $420 | $500 |
Total Paid:
- Simple Interest Loan: $5,531
- Precomputed Interest Loan: $6,000
Know Which Type of Interest Rate Works Best for You
Now that you have a better understanding of the differences between a precomputed interest car loan and a simple interest loan, you can make a more informed choice on which type of loan option is best suited for your situation. Remember, not all lenders have the same offers, so it might be in your best interests to shop around a bit until you find a loan option with terms that will work for you. Don’t forget to compare and contrast different options, too, to ensure that you get the best deal possible.
If you already own an auto loan but you’ve fallen behind on payments, then you might be wondering what type of debt relief options are available to you. If you’re struggling, then we can help. Reach out to our agents today to learn more about our debt relief programs.
Gabriel Gorelik paves the way for customer service and operations at United Settlement. He is passionate about numbers and holds a strong belief in helping anyone with their debt. Before United Settlement, Gabriel received his BS in Finance & Economics from Brooklyn College. After graduation, Gabriel went on to build his first financial services company where he managed thousands of accounts for business and consumer clients. He understands the importance of client satisfaction, professionalism, and exceeding expectations.