Accountants seem to speak their own language, using terms like loan amortization. To the average consumer, this phrase likely only comes up when they're trying to borrow money for something big, like a vehicle. But if you've ever taken out a loan, you're already familiar with the concept of loan amortization, even if you didn't know it by its formal name.
What is Car Loan Amortization?
Generally speaking, amortization refers to the process of dividing payments over a period of time. In the case of a car loan, amortization means creating monthly payments out of a fixed-term loan. If your $15,000 loan promises repayment in 36 months, for instance, the lender will divide that $15,000 by 36 to amortize it.
However, with any loan there will be interest. So your amortization won't be an even $416.67. You'll have monthly interest payments tacked onto that amount. But the fact that it is worked out ahead of time means you'll have one predictable monthly payment, making it easier to create a budget. The amount will also get easier to pay if you happen to get a raise or pay down other debts during the term of the loan.
Car Loan Amortization Schedule
There are online calculators, but with all the information, you can easily calculate your loan's amortization schedule. You'll need to know the term of the loan, the price of the car and the annual interest rate. You don't have to have this information to make these calculations, though. You can learn what your monthly payment will be by simply knowing the interest rate you're likely to get.
To calculate your monthly payment, you'll first divide the annual interest rate by 12 to break it out by each month. You'll also divide the amount of the loan you're taking on that car by the number of months you'll be paying on it. Keep in mind that just because a car costs $15,000, that doesn't mean that you'll be taking a loan for that full amount. Chances are you'll be required to put some form of down payment on the car you purchase. So if you paid $2,000 down on a 36-month loan on a $15,000 car, you'd divide $13,000 by 36 to get $361.11. You would then add the monthly interest to get the amount you can expect to pay each month.
Car Loan Amortization Extra Payments
If you pay only what your monthly payment requires, you can expect to pay your car loan off in the time specified. But there is something you can do to reduce the time you'll pay on the loan. At any time, you're allowed to pay money toward the principal on your loan, reducing the length of time you'll owe on the car. This means fewer months you'll pay interest, potentially saving you hundreds of dollars.
Before you try paying extra, first check with your lender to make sure you're allowed to do so. You can then work to scrape up extra money to occasionally make an extra payment or two. It's important to note that this won't change your loan amount in the months that follow. You'll just simply find you're getting that final bill much sooner than you would have otherwise.
With amortization, you don't pay equal parts interest and principal over the course of your loan. Amortized car loans use something called simple interest, which charges interest based on the amount of principal remaining. Since the amount you owe will go down over the course of your loan, you'll find that more of your monthly payment is going toward principal rather than interest.
This is also how paying extra can help. Even if you only pay $10 toward principal in a given month, that's $10 less that you're being charged interest on. This means that you're actually saving money. However, you may want to check into your other debts. You could find that you'll be better off paying extra on a higher-interest loan like a credit card.