The Financial Network

Is a 3% interest rate car loan really a 3% interest rate?

The average car loans that you see are often calculated with simple interest, which is far higher when calculated for effective interest, the actual interest when compounded.

This is due to Simple interest assuming your loan total remains the same throughout the loan period, but in reality, the loan gets smaller every year as you pay the installments.

So in reality you are paying more interest effectively per year as time goes on.

So what is the actual effect interest rates that we are paying? If we calculate using effective interest rates, that 3% Interest Rate Car Loan over a 84 months period is actually around  5.5% when calculated as effective interest rates!

How? Let us show you the Actual costs involved!

Let’s break it down: Consider a $300,000 loan over 84 months. With a simple 3% interest, you’d pay around $63,000 in total interest, making the actual loan $363,000.

Divide that by 84 months (7years) and you get a monthly payment of approximately, $4321.43 per month!

Now, if we calculate how much compounded interest that $4321.43 payment is against the original loan of $300,000 in a TVM calculator, you get 5.57% in Effective Interest Rates!

That is a huge 2.5% ++ difference from the actual 3% stated! If you are paying back your loan using compounded interest of 3%, that is around $26,000 difference!

It is very important to know what your loan is costing you, so that you can make accurate and informed decisions. While Car loans are only available in Simple Interests, knowing how much it is actually costing you can help with managing your finances.

If you want to know more, you can consult our experts for more information via the link below:

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10th Jan 2024 – Leon Leung

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