Auto Loan Math: Time Really is Money
Richard BarringtonLoanBiz Columnist
Any time a person is
paying interest, time is money. People tend to understand that lower interest
rates will save them money, but they focus less on the effect that time will
have on how much they spend. The simple truth is that the longer it takes to
repay borrowed money, the greater the total interest expense on the loan will
be. This is something auto loan shoppers should keep in mind when choosing the
length of their loan. Auto loans are commonly available in a variety of time
periods. People who are drawn to the longer time periods should think twice
about how much money this is costing them.
A Few Short Trips in
a Car Payment Calculator
A few short trips in a car payment calculator can help
clarify the actual interest expense of a loan. Running the same loan amount for
periods of two, three, four, five, and six years shows how much the total loan
expense increases with each addition of time.
Assuming a car buyer borrows $20,000 at a 7.0% auto loan interest rate, a two-year loan would cost a total of $1,491 in interest expense. Keeping the same principal amount and auto loan interest rate, here is how much borrowing over longer time periods would add to that interest expense:
- Moving from two to three years would add $740
- Moving from three to four years would add another $757
- Moving from four to five years would add another $773
- Moving
from five to six years would add another $790
Note that additional years not only add interest expense,
but each successive year adds a greater amount. This is because of the compounding
effect of interest over time. In total, a six year auto loan would have more
that triple the interest expense of a two-year loan.
The above figures actually understate the increase in
interest expense with time, since the auto loan interest rate would typically be
higher for longer-term loans.
Redefining
Affordability
Naturally, people are drawn to the longer time periods
because they lower monthly payments by spreading the loan over a longer period
of time. However, instead of defining affordability simply by the size of the
monthly payments, borrowers would do well to run a few different time periods
in a car payment calculator. The results would show that lowering the monthly
payment actually costs them more in the long run.
Looking at an auto loan this way might change how borrowers
define what they can afford. After all, the less interest expense they pay, the
more purchasing power they will have in the future.
Source:
MSN
Autos
About the Author
Richard Barrington is a freelance writer and novelist who previously spent over twenty years as an investment industry executive.
