What is Car Loan Amortization?
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Auto loan amortization refers to the process of paying off a car loan over a period of time called the loan term. When you make monthly payments on your amortizing loan, part of the payment is applied to the loan principal — the amount you borrowed — and part goes to paying interest. With each payment, your loan balance decreases until the loan is paid off.
Many car buyers focus only on the total monthly car payment, but understanding how your car loan amortizes and the details of each payment could save you money in the long run.
Here’s how car loan amortization works
To understand how car loan amortization works, it’s helpful to think of your loan in two parts:
Principal is the total amount you borrow to cover the cost of the car.
Interest is the amount you pay a lender to borrow money. Your interest rate (the percentage you pay to borrow) and any lender fees are combined to be your annual percentage rate (APR).
The total payment amount you owe the lender doesn’t change from month to month, but the portions of your payment going to principal and interest do. That’s because the majority of car loans use a simple interest calculation. Each month, on the day your payment is due, the amount of interest you owe is calculated based on your remaining loan balance. As your loan balance decreases, you owe less interest, and a larger portion of your payment goes to pay down principal.
Here’s an example of how amortization of an auto loan works. If you get a $30,000 car loan with a 60-month term and 7% APR, your monthly payment would be $594.04. With your first payment, $175 would go to interest and $419.04 to principal. That reduces your principal to a new balance of $29,580.96. The following month, your interest calculation is based on the new principal balance. Your payment would still be $594.04, but $172.56 would go to interest and $421.48 to principal.
Although it isn’t common, some lenders use precomputed and not simple interest for auto loans. Interest is calculated at the beginning of the loan based on the total loan amount and split equally among monthly payments. As the loan balance decreases, the monthly amount of interest paid doesn’t change.
What is an auto loan amortization schedule?
A car loan amortization schedule shows you details over the life of a loan, from your first payment to the day your loan is paid off. An amortization schedule is usually in a table or chart form with month-by-month information about the following:
The monthly payment amount (which doesn’t change).
How much of each month’s payment will go to principal.
How much of each month’s payment will go to interest.
The total remaining principal balance after the payment is applied that month.
The total number of payments you will be making.
NerdWallet’s auto loan calculator can create an auto loan amortization schedule for you. After entering your information, select “Show amortization schedule.” The calculator will also show you the total interest cost, total loan payments and payoff date.
NerdWallet Auto Loan Calculator
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How you can use an auto amortization schedule
The decisions you make when taking out a car loan, or refinancing an existing one, will affect your total cost for the loan. A car loan amortization schedule can help you look beyond monthly payments to see how your choices will cost or save you money in the long run. Here are a few examples.
Choosing a loan term
Going with a long auto loan term may seem like a good idea, because it can lower your monthly payment. However, the longer your loan term the slower the loan amortizes, so you will pay less toward principal early in the loan. An amortization schedule can show you how different loan terms affect the reduction of your principal balance and increase or decrease the total interest you pay.
Making a down payment
The amount you put down on a car up front reduces the principal amount of your loan to be amortized. An amortization schedule can show how putting more or less down will affect your total cost of interest.
Comparing auto loans
If you’re comparing auto loans from different lenders, ask to see each loan’s amortization schedule. It’s no surprise that the loan with the higher APR will cost more, but the amortization schedules will give you the total cost difference. Also, check the number of payments to ensure each lender is amortizing using the loan term you expected.
Knowing whether a monthly car payment fits your budget is important, but so is having a full view of what you’re paying over the course of a loan. An auto loan amortization schedule provides that view and enables you to see how certain actions could result in paying less.
