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Do Car Loans Have Compound Interest?

In general, car loans are subject to simple interest. That means that when your loan is assigned an interest rate, it is multiplied by the total amount financed. This gives a set balance that must be paid. That balance is divided by the length of the loan to determine your monthly payment. After each on-time payment a set amount will be applied to the interest first, then any remainder will be applied to the principal. Since car loans are subject to simple interest, the amount applied to interest drops each month, while the amount applied to the principal increases.

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How is Your Interest Rate Determined?

The interest rate you are offered on a car loan depends on several factors: credit history, income/debt ratio, and the age of the car being financed. Obviously, the better your credit history/score is the less of a risk you are. Less of a risk equals lower interest rate. Lenders want to see that you total commitment to debt repayment is less than thirty percent of your after-tax income. The closer you are to the thirty percent level, the higher your interest rate will be. New cars qualify for lower interest rates than used cars. Certified used cars qualify for lower interest rates than non-certified. These age considerations are parlayed into risk categories. Older, non-certified cars are considered to be more at risk for high dollar repairs, thus compromising your ability to make your loan payments on time.

About the Author

The author has many years of experience in automotive finance and insurance. However, each consumer's situation is unique. It is best to contact a finance specialist for further assistance.
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