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I have a question that perhaps someone on here could answer. A relative purchased a new car last year and financed it using a 5 year fixed rate auto loan at roughly 3.5%. The monthly payments are identical each month- around $550. However, a payment breakdown shows each installment having wildly different amounts going towards principle versus interest. It seems that the timing of each payment during the monthly cycle affects the interest amount significantly. The loan appears to be structured using a 365 day simple daily interest formula of some sort. The general theme is that paying on or near the due date results in the maximum possible interest, whereas paying 15 days earlier cuts that amount in half.
My question is this- Does the timing of each monthly payment actually reduce interest over the long run? Or is it a zero-sum game? For instance, if the relative begins making each monthly payment as early as possible in the payment cycle- lets say 30 days before the due date- will they save interest? Or do they just wind up paying more the next month due to a longer duration between payments? If there are exactly 30-31 days between each due date, it seems the benefits would be limited to one month, right?
There seems to be very little information online about this exact topic- most articles are in regard to making extra payments or more frequent payments. Any info from someone familiar with this would help. Thanks.
Well, tot up the total of all the payments and compare that to the loan amount; then calculate the same for various standard interest rates. That'll tell you what the effective interest rate is, now compare that to the stated interest rate, and you'll know whether you're paying MORE or LESS than a normal loan would be for the same stated rate. Ought to take about a half hour with an internet payment calculator.
Well, tot up the total of all the payments and compare that to the loan amount; then calculate the same for various standard interest rates. That'll tell you what the effective interest rate is, now compare that to the stated interest rate, and you'll know whether you're paying MORE or LESS than a normal loan would be for the same stated rate. Ought to take about a half hour with an internet payment calculator.
I'm not sure what you mean. The interest rate is what it is. If the stated rate is 3.5% that's the rate. The question is not the interest rate, but rather the timing of each payment and how it affects the actual amount of interest paid over time. Does paying earlier in the monthly cycle result in paying less interest? Or are they better off waiting until each due date to pay?
In reviewing online articles, it seems that the total interest stated in the loan contract is the maximum amount one would pay assuming they pay exactly on time on each due date. The advantage to paying early is that it reduces the principle balance slightly faster since more of each payment goes toward principle instead of interest. Each subsequent payment carries interest based on a smaller principle amount. We are trying to determine if it is worth while to pull forward (i.e. pay earlier) each monthly payment to reduce costs. Or is it a fool's errand?
For a mortgage your payments monthly interest cost is calculated based on the prior month's principal balance. So it doesn't matter what day you pay in the month, as long as you make your payment on time to avoid any fees.
I would assume the same is true with an auto loan but there are so many loan terms out there I can't be certain.
If your relative is trying to pay it down faster, I recommend paying extra towards the principal each month. That would ensure the most savings in interest. Sometimes if you don't specify where your extra payment goes the loan servicer will apply it to interest, do not do that.
I have a question that perhaps someone on here could answer. A relative purchased a new car last year and financed it using a 5 year fixed rate auto loan at roughly 3.5%. The monthly payments are identical each month- around $550. However, a payment breakdown shows each installment having wildly different amounts going towards principle versus interest. It seems that the timing of each payment during the monthly cycle affects the interest amount significantly. The loan appears to be structured using a 365 day simple daily interest formula of some sort. The general theme is that paying on or near the due date results in the maximum possible interest, whereas paying 15 days earlier cuts that amount in half.
My question is this- Does the timing of each monthly payment actually reduce interest over the long run? Or is it a zero-sum game? For instance, if the relative begins making each monthly payment as early as possible in the payment cycle- lets say 30 days before the due date- will they save interest? Or do they just wind up paying more the next month due to a longer duration between payments? If there are exactly 30-31 days between each due date, it seems the benefits would be limited to one month, right?
There seems to be very little information online about this exact topic- most articles are in regard to making extra payments or more frequent payments. Any info from someone familiar with this would help. Thanks.
It sounds like the lender is using the true annual rate of interest broken down into a daily rate on the unpaid balance. Actually, that is the best and fairest way to do it.
It works something like this: The original amount of the loan at 3.5% annual rate would give a certain "daily" interest rate starting with Day 1. If you make a payment on day 15, then you are charged 15 days of interest at that daily rate. Anything addition paid (over and above the interest amount) is applied to the principal reduction.
Then, you start the calculations all over again for the next payment. If you then wait 30 days, you will be charged for 30 days of interest. Anything additional paid (over and above the interest amount) is applied to the principal reduction.
Then, you start the calculation all over again for the next payment. You keep repeating this process until the loan is paid in full. Again, this is TRUE interest rate and that's how it's figured. It is good that your relative is actually getting this interest rate since it is lower than the old "add on" interest that many lenders used to use and perhaps some still do.
There may be a date 10 days from the due date for payments to be "on time". The lender is allowing some time for slow mail, holidays, weekends.
So if you call the bank today say the amount due is $1k. If you ask for payoff amount would be $1k something. Quote is good for a number of days. After the date interest accrues a t maybe $1.50 per day.
In Excel you may be able to do amortization table. You owe $1k, payments need to be made on due date. Payments are divided between principal & interest. At the start of the loan most of the money goes to interest & not principal. The table will show you if you make say 48 payments what the balance will be. There are many ways to calculate interest.
There may be other programs/aps to show you "payoff car loan".
It sounds like the lender is using the true annual rate of interest broken down into a daily rate on the unpaid balance. Actually, that is the best and fairest way to do it.
It works something like this: The original amount of the loan at 3.5% annual rate would give a certain "daily" interest rate starting with Day 1. If you make a payment on day 15, then you are charged 15 days of interest at that daily rate. Anything addition paid (over and above the interest amount) is applied to the principal reduction.
Then, you start the calculations all over again for the next payment. If you then wait 30 days, you will be charged for 30 days of interest. Anything additional paid (over and above the interest amount) is applied to the principal reduction.
Then, you start the calculation all over again for the next payment. You keep repeating this process until the loan is paid in full. Again, this is TRUE interest rate and that's how it's figured. It is good that your relative is actually getting this interest rate since it is lower than the old "add on" interest that many lenders used to use and perhaps some still do.
You nailed it. It does NOT work like a mortgage. They use a daily simple interest formula, so interest accrues on a daily not monthly basis. If it was monthly like a mortgage then the timing of a payment would be irrelevant as long as it is paid by the due date. On a daily formula, interest accrues each day, so the earlier in the cycle you pay, the lower the interest you pay for that cycle. However, if you go much beyond one monthly cycle, the benefits of paying early diminish. The only lasting benefit seems to be the extra principle reduction from the first month, and each month after is based on a lesser principle amount.
I'm not sure what you mean. The interest rate is what it is. If the stated rate is 3.5% that's the rate. The question is not the interest rate, but rather the timing of each payment and how it affects the actual amount of interest paid over time. Does paying earlier in the monthly cycle result in paying less interest? Or are they better off waiting until each due date to pay?
In reviewing online articles, it seems that the total interest stated in the loan contract is the maximum amount one would pay assuming they pay exactly on time on each due date. The advantage to paying early is that it reduces the principle balance slightly faster since more of each payment goes toward principle instead of interest. Each subsequent payment carries interest based on a smaller principle amount. We are trying to determine if it is worth while to pull forward (i.e. pay earlier) each monthly payment to reduce costs. Or is it a fool's errand?
I don't understand what YOU'RE saying.
You have a monthly payment, which of course consists of some fraction in principal and some fraction in interest. Unless you double up payments, the payment is the payment. If it's a four year loan you've got to make 48 payments and then the loan's paid. The balance of interest vs. principal in each payment, or how they vary for a given payment depending on when in the month you pay, doesn't change the term of the loan nor how much each payment is.
If the payment's due on the 30th of every month, the same amount will be due and the same number of payments will be due, whether you pay on the 30th or the 2nd. (Of course, if you double up, that speeds up the retirement of the loan, and that's a different matter.) The calculation of the relative fraction of principal and interest in a single payment is just part of the internal workings of the loan and largely irrelevant. Pay every payment on the 2nd of the month and you're still on the hook for the same 48 payments at the same amount of each payment, i.e., your total cost is the same.
Unless you've gotten hold of an EXTREMELY exotic loan.
You nailed it. It does NOT work like a mortgage. They use a daily simple interest formula, so interest accrues on a daily not monthly basis. If it was monthly like a mortgage then the timing of a payment would be irrelevant as long as it is paid by the due date. On a daily formula, interest accrues each day, so the earlier in the cycle you pay, the lower the interest you pay for that cycle. However, if you go much beyond one monthly cycle, the benefits of paying early diminish. The only lasting benefit seems to be the extra principle reduction from the first month, and each month after is based on a lesser principle amount.
Correct. If a person pays only the first payment early and then pays the rest of the payments on about a 30-day interval, then there will be a slight savings in interest paid, but very slight.
Where this method REALLY benefits a person is if they can pay a large chunk of EXTRA money in the early years of the loan. For example, suppose a person gets a tax refund of $3,000 and decides to pay all of this refund as an extra payment early in the life of the loan.
This $3,000 applied 100% to principal reduction might cut a year or two off the total repayment time of the loan even though it is only approximately the amount of one or two monthly payments.
Many people just don't realize the benefit of paying EXTRA on their mortgage loan in the early years of the loan. This is especially true the higher the interest rate is that they are paying. If their mortgage interest rate is only 3% or so, then I wouldn't be in any big hurry to pay it off. OTOH, if their mortgage rate is closer to 7% or more, then extra payments early in the life of the loan can knock YEARS off the total repayment time.
Correct. If a person pays only the first payment early and then pays the rest of the payments on about a 30-day interval, then there will be a slight savings in interest paid, but very slight.
Where this method REALLY benefits a person is if they can pay a large chunk of EXTRA money in the early years of the loan. For example, suppose a person gets a tax refund of $3,000 and decides to pay all of this refund as an extra payment early in the life of the loan.
This $3,000 applied 100% to principal reduction might cut a year or two off the total repayment time of the loan even though it is only approximately the amount of one or two monthly payments.
Many people just don't realize the benefit of paying EXTRA on their mortgage loan in the early years of the loan. This is especially true the higher the interest rate is that they are paying. If their mortgage interest rate is only 3% or so, then I wouldn't be in any big hurry to pay it off. OTOH, if their mortgage rate is closer to 7% or more, then extra payments early in the life of the loan can knock YEARS off the total repayment time.
This is true. But considering that most sell their homes long before any standard mortgage term has been satisfied, I'd wager that the big benefit to this method for most would be in owing less overall (via interest) and, thus, being able to recoup more money in equity, etc., when they do sell.
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