by Jim
Today I have been on the phone with the company in charge of my car loan. This month was the first month that I made a payment on the van, after looking online I couldn’t find what my principal balance was. No where on my statement or online did it state. Not only that, this company didn’t have what amount was going to principal and what was going to interest.
So I called the company up. And it turns out we are on a simple interest loan, meaning that interest is calculated daily. This might have been the case with the car as well, but I was pretty illiterate when it comes to loans back then. Still am if I am being honest with myself.
I always thought all loans were like the standard loan where interest was calculated monthly. Now that I look back at things, I bet almost all my loans ever were on a simple interest loan. Makes sense the loaners want to make all the money they are owed, right?
So after researching how exactly a simple interest loan works, this is what I came up with. You divide by 365. This converts it into a daily rate, you then multiple that by principal amount to obtain the interest due for each day.
This amount is recorded in a special accrual account, which increases everyday. No interest accrues on this account. When your payment is received, this account gets paid off first and what is left over is used to reduce the balance.
Where borrowers start hurting is if they make a late payment. A standard loan has a grace period within which borrowers can pay without penalty. On a standard interest loan, borrowers pay interest for every day they are late.
People who make extra payments actually do better with a standard loan as well. Most lenders will credit extra payments received within the first 20-25 days of the statement period against the balance at the end of the preceding month. So for instance, someone pays $1,000 extra on day 20, will save the interest on that $1,000 for 20 days. With this kind of loan the interest still accrues for those 20 days.
So I am basically at a lost what to do. I was thinking of using this coming month’s snowball to make an extra half payment in the middle of the month, then paying the other half on the due date. And afterwards work on a bi-monthly schedule. This will give me an extra payment a year. But from what I am reading this will not really help. The only thing that works better for me is if I make my monthly payments early. I really don’t know how I can do this, since the majority of our household income comes in the beginning of the month and this loan is due at the 7th of every month.
I could really use everyone’s help in understanding this. I am not even sure if what I just wrote up is 100% accurate, since it is just my interpretation of what I read. Remember I am loan illiterate. What would you all do?
Yeah, I think generally car loans get all their interest paid up front, while on a home mortgage the interest owed every month is less, because the principal goes down every month.
So once you pay a car loan for a few years, if you pay it off early you aren’t really saving much if anything at all, because you have already paid off the majority, or even all, of the interest, but you still need to pay off the principal, too.
I think the best that can be said for paying off a car loan early is that it will increase your cash flows, not that it will necessarily save you money in interest, like paying off a home mortgage early will. It might save you a little, depending on when in the life-cycle of the loan you pay it off, but the finance companies are smart to get all their lovely interest up front for a majorly-depreciating asset. I mean, it’s always good to increase your cash flows, of course, which is a good reason to pay off any loan early.
I think all car loans are like this, so you don’t have to feel bad that you were “taken”. It’s just the way it is. That’s why it’s best to pay cash for a car. Or, one of the reasons, I should say.
Of, course, I’m just a chubby housewife from Texas, so I could be wrong about all this high-falutin’ finance stuff. But I think that’s how car loans work. Yep. That’s one reason I pay cash for cars, and take really good care of them and drive them ’til the door knobs fall off.
I don’t believe this is true. Making extra payments on a car works exactly like on a mortgage, as long as you that the extra goes to reducing the principal and not just pre-paying the next payment.
Jim, as folks say below, don’t worry too much about how your interest is calculated or when exactly you make your payments, just make sure that payments are on time and extra payments count toward principal. Daily calculated interest works against you, but really is not significant compared to what the interest rate (APR) is.
I hope I don’t sound like a huge *ss, but it does drive me a little crazy when folks don’t understand the terms of their loans and then write it off as being “loan-illiterate” as if that’s OK. I don’t think it should be OK! Learning at least the basics here seems to me an important part of the process of getting out of debt.
That’s exactly it Joe, I am not trying to write it off as being “loan-illiterate”, but more trying to learn exactly what I can do to make the best of it. So are you suggesting that I just follow the snowball payments. As in keep up the plan I already have and when it is time to get to the car (hopefully by the end of this year) hit hard? I shouldn’t do the bi-weekly payments because it is just going to pre paying the next payment?
I think AS’s message below is the most succinct response and captures my position well.
Re-reading the post, can you let us know who the loan servicer is that will give you a statement without letting you know the balance of the loan, division between principal and interest, etc.? Shame on them!
I believe that paying any extra you can each month in addition to your minimum payment would reduce the principal and thus reduce the interest charged the next month. That will enable you to pay it off faster as you will pay less interest. I believe that this kind of loan is very common for auto loans.
Don’t over complicate it. Trying to figure out exactly when to make a payment will drive you nuts.
The key with making an extra payment is to make sure it is applied to the PRINCIPAL and not to advance when your next payment is due. Let’s pretend you make a $500 payment. You don’t want them to say “this covers May and June” so then your next payment is due in July. Even if you continue to make your monthly payment, it will just give you padding before the next payment is due. And that also could give you enough rope to hang yourself if you decided to “skip” a payment because you are ahead. KWIM?
If you want to go every other week for payments, you can’t do it on autopilot. You have to be aware of how it is being applied.
I wasn’t planning on hitting the car with extra payments, but now that I read what I wrote. Basically all I would be doing is paying toward the interest and not really be doing anything, is that correct?
If you do bi-weekly payments, you will be advancing your payment schedule by one month over the course of a year. You would have to clarify with the lender how that payment is broken down. But unless you make sure that anything above and beyond your minimum monthly payment is going to principal….you aren’t really advancing your debt repayment.
If you really aren’t sure and want to play it safe….in the months that you have an extra half payment, go and manually make the payment as an “over payment” toward principal.
I think you are getting lost in the details. I would really say, for now, until you really get a handle on budgets, cash flow, etc….just worry about making a monthly payment…on time.
Thank you Mysti, I think you might be correct.
You are most welcome. 🙂
I agree with this Jim. Lenders are notorious for applying extra payments incorrectly even with instructions. My coworker sent an extra principal payment to Wells Fargo every month with a note saying please apply extra $200.00 to principal. They invariable would not. Then she would have to call in and they would correct it. She tried sending in the principal payment as a separate check, same thing.
You have to watch these folks like a hawk. They count on inattention and apathy in their debtors an use it as opportunities to take more of their money.
PS, good job on researching the simple interest loan. It is the only kind of loan I would ever consider because you can reduce it at will. Years ago when I first started working and managing money (shortly after the earth’s crust cooled) they were called direct reduction loans. You always want to be able to pile extra money on your principal.
Did they give you any clarification when you actually called and talked to them? I, too, am totally loan-illiterate, but I remember with my first car loan I was told that any extra I paid went straight toward the next month’s interest (not principal balance) UNLESS you specifically write on the check, “Extra money toward principal balance.” If you pay online you literally have to CALL (every.freaking.month) to instruct them to put the extra toward the principal instead of to interest. For the loan I had at the time (this was a decade ago, so who knows if things have changed), I was told that if I didn’t give the explicit instructions to put extra $ toward the principal that it would simply be rolled over and applied to the next month’s interest for up to 3 months out. If I was 3 months ahead on payments, then they would start applying money toward the principal. Does that make sense? Kind of hard to explain and it’s still kind of over my head, but that was my understanding and I think that’s a pretty standard way of doing it with auto-financing.
Makes perfect sense Ashley! Thanks.
There are two reasons why you should go ahead with the plan you have of making that extra payment and then going with a bi-weekly payment plan. First, the principal is still going to be reduced by that payment, whether it’s a whole payment or a partial payment, or even if it’s a half payment.
Second, by continuing with the bi-weekly payment plan, you will effectively be making an extra payment per year. There are twelve monthly payments due, but if you pay every two weeks, that will be 26 half payments, which equals 13 true payments.
Let’s do some calculations. With the Principal the way it is, my daily APR would be $6.35. If I times that by 14 (days) that would $88.90. Half of my monthly payment would be $180.74. So $91.84 should go to premium. Which would make my principal $17735.54. That should make my daily APR go down to $6.32 times by 14 = $88.48. $92.26 goes to premium. So all together that month 185.10 would go to principal and 177.38 to interest.
Now I try with only one payment… using my daily APR at the beginning of $6.35, I multiply that by 31 to get the interest I would pay for the month, $196.85. Subtract that from my payment of $$361.47 and get 164.62.
Ok I must have done something wrong. Because the top example I am only using 14 days (essentially every two weeks) and the bottom I used 31 days. If everything is correct I would pay more on my principal by using the bi weekly plan then once a month.
Which makes Alice correct… am I right?
If you split up your payment bi-monthly and have them both auto scheduled after the statement date you would save $6.81/month on interest in the first month. The savings then would increase slowly (~1cent per month). So if you could get it automatic and applied correctly with your loan vendor I would advocate bi-monthly payments for the free savings on interest.
I would not advocate bi-weekly payments:
1. The potential for issues on such a small return ($5 a month versus potential for a late fee)
2. Also, you’d want the extra payments to be applied to the highest interest rate loan.
Your welcome.
What I did was make payments at 4 weeks apart. I started by clocking 31 days within my due date, and made the payment two payments. After that, I continued making the payments every 4 weeks. By the time I paid off my car loan, I was two months ahead.
Do not overcomplicate this at first.
1. Make your required payments on time.
2. Make extra payments when you can, and make sure you indicate to them they need to apply the extra money to principal.
3. Avoid any fees for extra payments.
If you’re dealing with a reputable firm, the above won’t be hard. They may play games with you for mid-cycle payments, etc, but the key is to avoid late payments, and make extra payments to principal to get ahead.
All interest is calculated daily; amortized loans just guarantee that if you make the payment requested, you will be paid off when they say you’ll be paid off. No matter what, if you make extra payments you will pay the loan off earlier. As you said, the danger is in making late payments or missing a payment.
I also would no fool around with two 1/2 payments a month. That could come back and bite you, even though it would equal an extra payment per year. Just pay the additional 1/12 with each payment if you can’t manage any more extra and mark it “extra principal”. I have paid off many loans in my lifetime, all early, by making extra payments.
Ok so the question is should I just stay on the snowball plan and not worry about this loan till it’s turn?
I would wait. Just make the monthly payments for now and concentrate on whatever debt is Enemy #1.
Stay the course, Jim! Get rid of the consumer debt, then hit the cars.
not sure why you want to make extra payments on your new van. if you are trying to do the snowball principal then it is all set out for you. your credit cards and personal loan all have higher interest rates than the auto loan. the snowball principal says to choose one debt and focus solely on that until it is gone so that you can see more immediate results. the immediate results is the driving force behind the snowball principal and the reason why it is so effective at reducing debt. putting a bit here and a bit there is kinda like bailing a sinking ship with a teaspoon because it looks like nothing is really happening. i can tell you from personal experience that being debt free is the best feeling there is bar none.
The main question was basically should I split my payments into two bi monthly payments. I would have to use my snowball this month to go to the first half payment, just so I can get on schedule. I wasn’t planning on throwing money at it till it’s turn. I wasn’t trying to put a bit here and a bit there, Just seeing what was doable when the new month comes along.
did you ask your lien holder if splitting the payments would be a problem? for me personally it would just be a hassle that i would get tired of doing. if it is okay with the lien holder and you feel you can keep up with it then go for it. it just looks like a lot of effort for very little payoff.
I think you are overthinking this. Like others said focus on making the payment (and paying all of your other bills ) on time. If you were planning on throwing all your snowball money at another debt stick with that plan.
The split of the payment could be tricky depending on when your payments are applied versus your statement. Say you get statements on the 5th and payments are due on the 25th. If you apply 1/2 the payment before the 5th most places would not count this towards your minimum payment. They would then say you were missing half of your monthly payment when you paid the second one. They would charge late fees for not paying in full. If you did this twice a month on the same dates it would work. But there’s a big chance it will get screwed up using bi-weekly payments as the year goes along and the date each month you pay gets shifted. You’d be better off picking (2) dates after your statement and adding the extra yearly payment or two in bulk in this case since you are still only paying minimums.
Some vendors make it VERY difficult to apply multiple payments per month correctly. On the other hand, if this was the loan you were snowballing you would want multiple payments per month to lower the interest. Especially if you get a windfall that is more than your monthly payment. That’s when you will make the real difference. But all the while I would advocate having your minimum payment set to auto-pull on the due date. Then you have your bases covered.
When I was paying down one of our student loans at 9% I sometimes would make 10 payments in a month. Some as low as $5. ?Then as you pointed out I slowly made a dent in the principal balance throughout the month. Interest saved may be minimal but a) it motivated me to add little chunks of money as I got it (and didn’t spend it!) and b) it lowered the principal mid-month to charge less interest.
Sorry if I confused you more! Its really not that difficult. Its more learning the tricks of the trade and how your individual loan vendors work. Some vendors make it easy with an “apply to principal” button, others make it more difficult. One of my loans I had to put a special extension on the account number on the check for it to apply correctly. There is no standard really. I’ve unfortunately had 140k+ of experience on 8? or so loans…
I wish I could send you a table or spreadsheet. It would be way easier to explain and for you to understand. Explaining math with sentences is TOUGH.
Your loan contract should clearly state how interest is calculated. If it’s a simple interest loan, you need to make the payment before or on the due date to avoid additional interest. If you pay early or additional payments, your total interest will be less than the potential interest on the contract. If it is a “rule of 78s” loan there is less of a reduction of interest for paying it off early. If you can’t figure it out, take the contract to your local banker and ask for their assistance.
I just read this “Rule of 78s” concept on wikipedia. Borderline usury!
I certainly hope it doesn’t apply in this case because the lender collects such a skewed share of the interest early it’s really bad for the borrower.
As mentioned previously, car loans can be tricky to get the extra payment applied to the principal versus just paying ahead on the next payment. My car loan was financed by a major car manufacturer. This loan required that a check be sent to a different address than where the normal payment was sent. I ended up just paying a bit extra every month and having it applied to the next payment after evaluating the savings versus the hassle. I got rid of the loan after a year because I was so annoyed by this. (Helped by money I had saved to refinance my house that wasn’t needed during the refinance.)
Just piling on to say, don’t make things complicated. This isn’t the loan you are concentrating on right now, so don’t worry about optimizing every last cent of interest on it. Pay one minimum payment on everything except your one debt you’re trying to kill.
I just financed my first car and just found out my auto loan is also simple interest. Even though I’m three years late to this post, someone else might have the same question in the future. Like a lot of people I thought the interest was calculated once every month, instead simple interest is calculated % of your principal everyday. People don’t realize negotiating the price of the car is important HOWEVER negotiating your interest rate is just as important and can save you thousands of dollars through the course of the loan! Since I am 23 and never financed a car they tried to take advantage of me and only told me my monthly car payment, knowing my monthly payment I used my finance calculator and calculated the percent interest in front of the car salesmen. When it came out to 9.8% interest I was shocked, even though I didn’t have a lot of credit I still had multiple credit cards and built up my credit score to around 745. When I called him out on that and started walking away he then went back to the back room and came out with an interest rate of 5.1 i didn’t mind that. Now if you take that 5.1% and multiply that by your principal and divide it by 365 that’s how much interest you are paying every day.
When you call the company to make an extra payment it will keep going towards next month payment UNLESS you specify you want it to go towards the principal. For example in September I payed the full amount of my monthly car payment with my first paycheck (I get paid Bi-weekly), and when I got my second paycheck I payed the same amount as the first. Now my next payment not due till November, what I wanted to do is have the second payment go towards the principal to save on interest. The faster you pay the principal down the less your going to be charged per day in interest. When I go to make my next payment in October I am specifically going to say I want this to go straight to the principal, but then the next payment I make after that (mid October) has to go towards the November car payment to avoid late payment penalties. Alright my story is over… hope this helps!
Hi Mark,
If my payment is due on the 29 of each month, and I already gave my first payment Nov 27 which more than half of the payment went towards interest and I’m barely trying to figure out how this type of loan works, do you know if I make my payment for Dec 29 on Dec 7 will I avoid paying the daily interest for the remaining days of the month and that way most of my payment will go to the principal instead of the interest ? (If that makes any sense) any help is greatly appreciated.