How Compound Interest Works
July 18, 2019
Financing your next new vehicle? You’ll want to learn a little about how interest works before you do. The more Macon, Warner Robins, and Milledgeville shoppers know about interest, the easier it will be to craft a solid auto loan plan.
Our team at Macon Car Credit wants to help you explore how compound interest works, along with some other related topics. Learn all the basics of interest below! Contact us if you have any questions.
Compound Interest: The Snowball
If you’ve ever seen a cartoon snowball roll downhill, you’re familiar with a concept called the “snowball effect.” It’s the perfect way to understand compound interest. Just as that snowball builds upon itself and grows as it rolls, the same happens when interest compounds.
When you’re saving, this principle works in your favor. You’ll earn interest on your interest and grow your money faster. However, when you’re borrowing money, this process works against you. You’ll pay interest on the money you’ve borrowed, as well as interest on that interest down the line.
Luckily for you, most car loans don’t use compound interest. They tend to prefer simple interest, a topic we’ll cover in detail below.
Okay… So What Is Simple Interest?
Simple interest makes borrowing easier for many car shoppers. It doesn’t compound the interest, instead charging only on the principle (i.e., the amount owed on the loan). Over time, this should save you money in interest compared to a compound interest loan.
Want to decrease the amount of interest you pay over time? Consider saving for a larger down payment. The more you pay up front, the less you’ll need to borrow. Building a strong credit history can help secure lower interest rates. To improve your credit before you apply for a loan, try these tips:
- Get current on all bills and credit card payments
- Pay all bills on time moving forward
- Keep credit card utilization below 30 percent (under 10 percent for best results)
- Try to avoid closing credit card accounts
Auto Loans & Amortization
Wondering how interest factors into your monthly payments? Most auto loans are amortized, meaning more of your payment is applied toward interest at the start of the loan. As the remaining principle lowers over time, your payments will gradually shift to favor paying off the principle over the interest.
Understanding how you’re paying off your loan is just as important as knowing your interest rate and loan amount. You can create an amortization schedule to see how much of your payments are going to interest vs. principle. Online calculators can give you a good estimate, and some lenders may provide this data for you.
Learn All About Interest at Macon Car Credit
We feel like we’ve barely scratched the surface when it comes to auto loan interest. If you want to learn more about this intricate topic, just reach out to our team at Macon Car Credit. We’ll help Milledgeville, Macon, and Warner Robins drivers explore auto finance in clear detail!