While a number of our clients looking for car financing are fairly familiar with some of the basic concepts tied to borrowing and lending, it’s important for us to remember that not everyone enters this realm with the same level of understanding and knowledge.
That means, for many people, whether you have just left school and are looking at your first vehicle, or you have moved to Australia from overseas, there are some important concepts to brush up on.
There is perhaps no more important concept than the two very basic mechanisms that determine how much you will pay across the life of your loan – the principal and interest. So if you’re new to the world of borrowing and loans, this little run through might help you start off and might also help you avoid a few traps.
Principal
The principal is the amount that you’re borrowing from a financier, whether it be a bank, non-bank lender or some other party.
In most cases, this would typically be the price of the car. However, it might also be higher to cover other elements tied to the purchase, such as optional extras, warranty coverage, and on-road costs.
Nonetheless, it pays to ask a few questions just in case there are a few extra charges here and there. You may be surprised to learn that quite often there is an administration or application fee associated with applying for a car loan, and once you factor this into the equation, you don’t want any rude shocks.
Compound interest
Compound interest is not just something you have to calculate once in school and never use ever again. In fact, you may realise this concept pops up in life more often than you care to think, whether it be the savings you earn on your money in the bank, your home loan, investment returns, and the like.
To understand why it is important, compound interest works like this. Let’s say you borrow $1000 at an interest rate of 10% per annum, which is equivalent to per year. The interest calculated the first time round will be $100, which is 10% of $1000.
But the next time that the interest is calculated, it will be 10% of ($1000 + $100 = $1100), which is $110. This assumes, of course, that you haven’t made any repayments over that period.
Generally when the interest at Time B is calculated, it will be 10% of principal + interest calculated at Time A less any repayments. As you might gather quite quickly, the amount you have to pay back keeps growing and growing, so the more repayments you make, and the quicker you pay back your loan, the less you will pay in the long run.
The Fincar team is here to help you with all your financing needs. Contact us today to help arrange your next car or equipment loan.