(US) My car loan interest rate is 5.5%, but 15% of my monthly payments go towards interest. Why?

Submitted by SupplyChainOne t3_10pdf62 in personalfinance

In September last year I bought out my lease, put $5,000 down, for a final loan amount of just under $15,000. This is all through Hyundai Motor Finance. My interest rate is 5.5%.

Aside from making a few one-time extra payments, I setup auto-pay for the 1st of every month, at my required payment amount, $345.83/mo. My monthly payments are "ahead of schedule" by 91 days.

I'm noticing, [see screenshot here], interest makes up a little over 15% of my monthly payment. As you can likely tell, this is my first car loan, and I am unfamiliar with how everything is calculated.

At a 5.5% interest rate - why is 15% of my monthly payment going to interest? Why shouldn't it be... 5.5%?

Am I essentially paying for expected full-term interest (if I were to make 0 additional payments above minimum monthly payment)?

I hope that makes sense. Thank you!

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theoriginalharbinger t1_j6jr7nk wrote

> At a 5.5% interest rate - why is 15% of my monthly payment going to interest? Why shouldn't it be... 5.5%?

Because that's not how that works. 5.5% means that you pay 5.5% of your current balance in interest. A basic example:

You have a $12,000 car payment. Every month, you owe interest. 5.5% of $12,000 is $660. This is an annualized number, so dividing it by 12 gets us the monthly number. Which is $55.

Now, your monthly payment might be $100, of which $55 is interest. It might be $200, of which $55 is interest. That doesn't matter. The 5.5% is 5.5% of the balance; it's not a proportion of the payment.

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lost_in_life_34 t1_j6jrgv6 wrote

the interest rate is per year and there is a simple interest formula everyone uses to calculate it based on the rate, time and accrual

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YoureGrammerIsWorsts t1_j6jx502 wrote

If you borrow $10k at 10% and paid $1k/year, 100% of your payment would be going towards interest. That would be an interest only loan.

Because you don't want to pay this forever, you ask for a constant yearly payment which will eventually get rid of the loan. Now you pay ~$1,175, but since the interest cost ($1k/$1175=85%) stays the same, that means $175 is going towards principal. Next year, you only owe 10% interest on $10k-$175=$9,825*10%=$983. So this time, $1175-$983=$192 is going towards principal. And repeat for 20 years and then the loan is paid off. It goes to show how powerful compound interest is, both positively and negatively.

BTW, if you wanted the interest specific part of your payment to be 5.5% of the overall payment, you would need to pay ~$950 next month. Then the following month, about $850

>Am I essentially paying for expected full-term interest (if I were to make 0 additional payments above minimum monthly payment)?

You need to clarify this portion of your statement: "My monthly payments are "ahead of schedule" by 91 days."

Are you paying future months, or are you applying your extra payments towards principal?

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SupplyChainOne OP t1_j6klkpu wrote

Thank you very much for this breakdown!

I applied my extra payments towards principal.

My loan term is 48mo, forgot to mention that.

Today, I called Hyundai, and they said they could apply the “three months I am over-paid” (91 days) to my principal. Which would bring my account balance to be “current”.

Seems to make sense.. chopping down the principal is best over anything else in the long term.. right? Any reason this ever wouldn’t be the case, if my goal is to pay the least amount of interest on this loan, and as early as possible?

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YoureGrammerIsWorsts t1_j6km6gv wrote

Absolutely you want to be paying that down towards the premium, but you also never want to miss a payment so I just wanted to make sure you weren't counting on those "91 days ahead" as a fall back option if you can't pay any month

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penguinise t1_j6k12bu wrote

>At a 5.5% interest rate - why is 15% of my monthly payment going to interest? Why shouldn't it be... 5.5%?

Because you're not paying down the loan in a single year.

Consider the following cases:

  • You pay the loan in full the day after you buy the car. You would pay effectively no interest regardless of your rate, because you didn't keep the loan very long (there might be some minimum duration or something). Your interest would be almost none of the amount you pay, or
  • You never pay off the balance of the loan, paying "interest only" and keeping the loan balance the same (this is common in business loans). 100% of your payments would be interest, again regardless of the rate.

When you pay off the loan in a fixed time period, it's somewhere between these two extremes. The interest rate is the percentage of the balance that is charged as interest - if the outstanding principal is $10,000 and your rate is 5.5% then $550 of interest will be charged on an annual basis. The amount of principal you pay in addition the interest is calculated in an amortization schedule in order to both:

  • Keep your payments the same amount every month, even though the amount of interest accrued each month will shrink as the balance goes down (you'll note that the interest portion of your payment shrinks each month), and
  • Pay off the loan in a certain number of months
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PM_Georgia_Okeefe t1_j6kxabx wrote

That's how installment loans work.

The first payment you make is mostly interest and a little principal. Then every month you chip away at the principal and the amount of interest paid goes down. This goes until the last payment when it's almost entirely principal.

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SoppingBread t1_j6jsxb3 wrote

APY is calculated over the term of thw loan. Since money towards principal reduces the balance, the interest payments are front loaded (more money towards interest early in the loan and less at the end). Amoritization calculaters visualize this effect.

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avalpert t1_j6kox7r wrote

No, it isn't calculated over the term of the loan. Interest is accrued (typically) daily on your outstanding balance. Interest payments aren't 'front loaded' and the total amount of interest you will pay isn't fixed up front.

The reason why more of your fixed payment is interest early on is because you have a higher balance accruing more interest.

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SoppingBread t1_j6kqven wrote

"Since money towards principal reduces the balance, the interest payments are front loaded (more money towards interest early in the loan and less at the end). Amoritization calculaters visualize this effect."

Firat sentence was an incomplete thought; APY is calculated for the term of the loan an figured into a normalized payment amount. Else you said the same thing.

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