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Auto Loan Math: Time Really is Money

Richard Barrington
LoanBiz Columnist

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Article Rating , 4 out of 5 based on 1 votes

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.

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