Getting financing to purchase a new or used vehicle can sometimes be a better option than paying cash for it. But when you’re reviewing auto loans, it’s important to understand how car loan amortization works.
Auto loan amortization simply means the process of paying off a vehicle loan. When a buyer uses financing to purchase a vehicle, the lender or financing company should provide that buyer with an auto loan amortization schedule. The schedule explains how the loan payments are applied over time.
Keep reading to learn how car loan amortization works, what factors affect car loan amortization, how to calculate amortization, and more.
Key Points
• Car loan amortization is the process of paying off a loan with a fixed repayment schedule, typically in equal monthly installments, which include both principal and interest.
• In the early stages of the loan, a larger portion of each payment goes toward interest rather than the principal.
• Over time, more of each payment goes toward reducing the principal, leading to a decrease in the interest portion.
• Amortization helps you understand the total cost of the loan, including interest, over the repayment period.
• An amortization schedule breaks down each payment, showing how much goes to interest and principal, and helps you track your loan’s progress.
How Car Loan Amortization Works
Amortization refers to the process of paying off a loan (a car loan or any other kind of loan) according to a predetermined schedule. When a loan follows an amortization schedule, the payments are divided between the principal owed and the finance charges. Specifically, part of each payment is applied to:
• Principal: This represents the amount of money you borrowed to purchase the vehicle.
• Interest: This is the cost the lender charges you for financing the vehicle with a loan.
• Fees: This includes any fees that are factored into your loan’s annual percentage rate (APR).
Auto Loan Amortization Calculation
The most important thing to understand about car loan amortization is how payments are applied. During the early part of the loan, a larger portion of each payment you make is directed to the interest and fees that you owe. Over time, this balance shifts so that by the time you reach the end of your loan term, more of your monthly payment goes to the principal.
This allows the lender or financing company to collect interest and fees sooner rather than later. If you end up defaulting on the loan midway or three-quarters of the way through the loan term, for instance, the lender has already collected a sizable amount of car loan interest and fees for the money it loaned you. Auto loan amortization effectively allows lenders to protect their investments.
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How a Car Loan Amortization Schedule Works
When you finance a vehicle, the lender doesn’t leave you in the dark about how your payments are applied. Instead, it provides you with an auto loan amortization schedule.
This amortization schedule breaks down for you:
• The total number of payments you’ll make on the loan
• The beginning loan balance for the month
• The ending loan balance for the month after your payment is applied
• How much of the payment goes toward interest
• How much of the payment goes toward fees, if applicable
• How much of the payment goes toward the loan principal
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Example Car Loan Amortization Schedule
If you’re still shopping for an auto loan, you can use an amortization schedule car loan calculator to estimate what your payments will look like over time. For example, say you want to take out a $20,000 loan with a 60-month term. You plan to put down $2,500 on the loan and you’ll pay $940 in taxes and fees at signing, leaving you with a total financing amount of $18,440. Assuming a 4% interest rate, your monthly payments would work out to be $339.60.
If you plug the numbers into an amortization schedule auto loan calculator, you’ll see that when you make your first payment, $278.13 would go to the principal while $61.47 would go to interest. By the time you reach your 60th and final payment, $338.53 would go to the principal while just $1.13 would go to interest.
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What Factors Affect Auto Loan Amortization?
There are a number of factors that can influence car amortization when you’re using financing to purchase a vehicle. The most important are:
• Down payment: The more you put down on an auto loan, the less you’ll have to finance and the lower your monthly payments may be.
• Trade-in value: Offering a vehicle for trade-in could also reduce the amount you have to finance and thus lower your payments.
• Fees and taxes: If you have to pay taxes, title fees, and other costs at signing that are rolled into the loan, that can affect the amount that’s amortized.
• Interest rate: Your auto loan’s interest rate also matters, since a higher rate means more interest paid in total over the life of the loan.
• Loan term: The longer your loan term, the more payments there are on your amortization schedule and the more interest you’ll pay altogether, even though what you pay per month may be less than you’d pay with a shorter term.
If you’re shopping for a vehicle, using a car loan amortization calculator to play around with the numbers can be helpful as you set your budget. You can see at a glance how choosing a shorter or longer loan term, financing a smaller or larger amount, or getting a higher versus lower interest rate can affect your financing costs.
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4 Things to Do to Improve Your Amortization Schedule
There are some things you can do to directly impact what your car loan amortization schedule looks like and how quickly you’re able to pay the vehicle off. They include:
1. Getting More Favorable Rates
Building your credit score may help you qualify for more favorable auto loan rates.
2. Larger Down Payment
Offering a larger down payment should reduce the amount you need to finance.
3. Less Expensive Vehicle
Adjusting your budget to allow you to purchase a less expensive vehicle will make a difference.
4. Making Extra Payments
Making extra payments toward the loan’s principal, beyond those dictated by the amortization schedule, will help.
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Refinancing Can Affect Car Loan Amortization
If you have a vehicle loan currently, it’s possible that you might want to refinance it into a new loan at different terms. Doing so could save you money if you’re able to secure a lower interest rate, but auto loan refinancing can also affect your car loan amortization schedule.
For example, if you end up extending the loan term, that can add months or even years onto your amortization schedule. And again, the longer the loan term, the more interest you could end up paying altogether, even if the new rate is significantly lower than your original auto loan rate.
Before refinancing, it’s a good idea to use an auto refinance calculator to determine how much you could save in interest to help you decide if it’s worth it. Keep in mind that you may have trouble refinancing an auto loan if you’re currently upside down, meaning that you owe more than the vehicle is worth. Lenders may require you to have a certain loan-to-value ratio to be approved for a refinance loan.
The Takeaway
When it comes to financing a vehicle, it’s important to ensure that you’re getting the most value for your money. Your auto loan amortization schedule is a major tool in understanding where your money is going.
Knowing how car loan amortization works can help you choose the right auto loan financing option for your needs in the future, and it can also give you some useful guidelines if you want to consider refinancing your current auto loan.
If you’re seeking auto loan refinancing, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your car in minutes.
FAQ
How is amortization calculated for car loans?
Amortization for car loans is calculated by spreading the loan amount plus interest over the loan term in fixed monthly payments. Each payment covers interest and reduces principal. Early payments mainly pay interest, with principal reduction increasing over time. Amortization schedules show how payments impact the balance monthly.
Are 72-month car loans a good idea typically?
A 72-month car loan offers lower monthly payments, but it typically costs more in interest over time and may lead to negative equity as the car depreciates. Shorter terms are usually better financially, as they build equity faster. A 72-month loan is best suited for budget flexibility, not long-term savings.
Is every auto loan amortized?
Yes, most auto loans are amortized, meaning payments are structured to cover both interest and principal over the loan term in fixed installments. With each payment, the interest portion decreases while the principal portion increases, gradually paying down the loan balance until fully repaid at the end of the term.
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