What is a simple interest auto loan?

You may have started researching financing options if you are in the market for a new car. Auto loans are readily available through traditional banks, credit unions and online lenders, but they’re not all the same. Beyond the varying loan terms each lender offers, you’ll also need to consider how they assess interest on auto loan products.

Simple interest auto loans are standard and have several benefits that make them attractive.

How a simple interest auto loan works

Simple interest auto loans come with a fixed monthly payment. However, the amount applied to interest each month is based on the outstanding principal balance. This is unlike compound interest, where you also owe interest on the previous accumulated interest.

More of the monthly payment is applied towards the interest on the account when you initially take out a simple interest auto loan. However, as you pay down the loan, you’ll notice that a larger portion of the monthly payment starts to go toward the principal. The amount the lender charges in interest decreases as the outstanding loan balance shrinks.

Here’s an example of how simple interest auto loans work.

Assume you get approved for using a four-year $36,000 auto loan with an interest rate of 6 percent. You’ll pay $845.46 monthly and $4,582.13 in interest over the life of the loan.

This table demonstrates that the further you are into the loan’s life, the more your monthly payment will go towards paying down the principal rather than interest.

Use Bankrate’s auto loan calculator to compute your total interest costs on your next auto loan.

Simple interest auto loan benefits

Simple interest auto loans come with a few key advantages that make them a popular option:

• More affordable payments: Since the amount of interest you pay each month is only based on the principal balance, you’ll get lower monthly payments than you would with a compound or precomputed interest loan.
• Sizable cost savings: If you decide to pay the loan off early, you could save a bundle in interest. For example, if you take out a five-year, $25,000 auto loan with a 5 percent interest rate, the monthly payment will be $471.78. Plus, you’ll pay $3,306.87 in interest over the loan term. But if you pay an extra $100 each month, you’ll pay the loan off in 49 months and save $651.04 in interest.

How to save on a simple interest auto loan

Use these strategies to save money on a simple interest auto loan:

• Pay more than the minimum: Paying extra each month or even doubling up on the payments can help you reduce the principal balance faster and pay off the loan early. But before using this strategy, confirm that the lender doesn’t assess prepayment penalties.
• Make timely payments: If you fall behind on loan payments, you could be charged late fees and accrue additional interest on your simple interest auto loan.
• Sign up for autopay: Doing so prevents you from having to worry about missed payments, unnecessary fees or adverse credit reporting, which could be costly over time.

Next steps

With simple interest auto loans, you will enjoy a fixed monthly payment and the ability to save a bundle in interest if you can pay your loan off early. And since they’re the most common option, you won’t have to search for a specialty lender.

When you’re ready to move forward, shop around for reputable lenders. And make sure to prequalify with at least three lenders before signing on with one.