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WalletPrep worksheet · Debt

How do car loans work?

Name ____________________ Date __________

Key ideas

  1. Judge a loan by its total cost. Payment × months shows what you will pay in all. The monthly payment alone hides the interest.
  2. Longer terms cost more in interest. In the example, $30,000 at 7% costs $4,483 in interest over 48 months and $8,034 over 84 months.
  3. 20/4/10 is a rule of thumb. Put 20% down, borrow for 4 years at most, and keep car costs near 10% of pre-tax income or less.

Vocabulary

APR
Annual percentage rate: the yearly cost of borrowing money, shown as a percentage. It is the number to compare on cards and loans.
Down payment
The cash you pay toward a home's price yourself at closing. A mortgage covers the rest.
Principal
The amount you borrowed, or the part of your balance that is still owed, not counting interest.
Credit union
A not-for-profit financial cooperative owned by its members, offering checking, savings and loans much like a bank.
Emergency fund
Cash set aside only for surprises like a job loss, a car repair or a medical bill. A common goal is 3 to 6 months of essential costs.

Work it out

Sam, 29, borrows $30,000 for a car at 7% APR (an example rate). The dealer offers 48 months at $718 a month or 84 months at $453.

  1. Borrowed
  2. Interest over 48 months
  3. Total paid, 48 months
  4. Borrowed
  5. Interest over 84 months
  6. Total paid, 84 months
  7. Interest, 84 months
  8. Interest, 48 months
  9. Extra cost of the longer loan

Check yourself

  1. A car costs $25,000. Under the 20/4/10 guideline, what is the down payment?

    • A. $2,500
    • B. $4,000
    • C. $5,000
    • D. $6,250

  2. Same amount borrowed, same APR. Which loan costs the most in total interest?

    • A. 36 months
    • B. 48 months
    • C. 84 months

  3. What does it mean to be upside down on a car loan?

    • A. You owe more than the car is worth
    • B. Your APR is higher than average
    • C. You missed a payment
    • D. The car is worth more than you owe

Your turn

Find your current or planned car loan and write down the payment, the months left and the APR. Multiply the payment by the months left to see what you still have to pay in total.

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Answer key

How do car loans work?

Work it out

  1. Borrowed$30,000
  2. Interest over 48 months$4,483
  3. Total paid, 48 months= $34,483
  4. Borrowed$30,000
  5. Interest over 84 months$8,034
  6. Total paid, 84 months= $38,034
  7. Interest, 84 months$8,034
  8. Interest, 48 months− $4,483
  9. Extra cost of the longer loan= $3,551
  1. The 84-month payment is $718 − $453 = $265 lower each month, which makes it look cheaper.
  2. Over 48 months Sam pays $4,483 in interest. Over 84 months he pays $8,034, because interest runs for 36 more months.
  3. The longer loan costs $8,034 − $4,483 = $3,551 more, and Sam makes payments for three extra years.

Check yourself

  1. C. $5,000 20% of $25,000 is $25,000 × 0.20 = $5,000.
  2. C. 84 months Interest is charged every month on the remaining balance. The more months you pay, the more interest adds up.
  3. A. You owe more than the car is worth Upside down, or negative equity, means the loan balance is higher than the car's value.