On a simple-interest car loan, the common kind, every extra dollar you pay stops the interest on that dollar for the rest of the loan. A precomputed loan sets its interest up front, so paying extra barely dents it. Check your contract for the interest method and any prepayment penalty before you pay ahead.
The gap between the two is wide. By our math, an extra $100 a month on a $30,000, 60-month simple-interest loan at 8% saves about $1,100 in interest and ends the loan 10 months early. A precomputed loan returns a fraction of that.
On a precomputed loan, the lender figures the interest for the whole term on day one and adds it to what you owe, so extra payments don’t reduce the interest. You get interest back only when you pay off the entire loan, as a refund of the part the lender hasn’t earned yet.
Paying ahead skips only the loan’s last months, which carry the least interest because the schedule loads it into the early payments. The Rule of 78s, a refund formula federal law bars only on loans longer than 61 months, shrinks the refund further. Under that formula, by our math, the same extra $100 a month on a precomputed $30,000 loan saves about $130.
Check before you send an extra dollar. Your contract’s Truth in Lending disclosure, the section that lists your annual percentage rate and finance charge, says whether you’d owe a penalty for paying early. Some states ban those penalties on certain loans. Then search the contract for “simple interest” or “precomputed.” If neither turns up, call the lender and ask.
If yours is precomputed, keep the extra money in savings, where it earns interest, and pay the loan off in one payment once the savings cover the payoff. Before you do, ask the lender for a payoff statement. Federal law requires it to show your interest refund, and the first one each year is free.
Even on a simple-interest loan, two things come first. Pay off any credit card balance, since cards usually charge far more, and build an emergency fund so the next repair doesn’t land on a card.
After that, every extra dollar on an 8% simple-interest loan earns a guaranteed 8%.
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