What's the difference between a simple interest rate and precomputed interest on an auto loan?
Precomputed interest results in the total interest due under the loan being calculated IMMEDIATELY. It is then spread equally among monthly payments. Simple interest – which is far more common - calculates the interest based on the outstanding balance of the loan either on a daily or monthly basis.
Precomputed interest is an uncommon way of calculating interest payments for your auto loan. It benefits the lender if you pay more than the minimum balance each month or pay off your loan early. If you plan to pay your loan off early, you want to make sure lenders are using a simple interest rate, which is generally more common.
Simple interest rate
The simple interest rate formula (also referred to as an amortizing rate) calculates the interest owed on a daily or monthly basis. The amount of interest you pay each month is calculated based on your actual outstanding balance on the day your payment is due. If you tend to make more than your monthly payment each month, the amount you owe – or your principal – gets smaller as you pay down your loan.
Precomputed interest rate
With a precomputed interest rate, the interest is added to your principal at the beginning of your loan and then split into monthly payments. This formula allocates more of your payment to interest during the first part of your loan. Making extra payments does not reduce the principal amount (or interest) owed.
If you’re planning to pay off your loan early, a precomputed interest rate would mean you’re ultimately paying more in interest. However, you may get a refund of some “unearned” interest.
See different ways to get an auto loan
You have several options to consider when buying a new car or getting an auto loan. Learn how they can affect your overall money picture.