How to calculate housing and car loan interest?
Perhaps you may not aware the way our car loan interest and the housing loan interest are calculated differently.Housing loan interest is calculated based on the principal of the loan that you have and the interest is not fixed. Principal of your loan is the amount of money that you still owe the bank.
Car loan interest is calculated based on the total amount of loan that you have and the interest is fixed.
Housing Loan
For example, you borrow $50K from a bank at 5% interest rate for 5 years.
1 year housing loan interest:
$50K X 5%
$2,500 (Yearly)
First month housing loan interest:
$2,500 / 12
$208.33 (First Month)
Depending on the monthly installment amount that you have, let’s say $1K per month, you will reduce your principal from $50K to:
Renew Principal $ after first payment:
$50K – ($1K - $208.33)
$49,208.33 (New Principal)
The second month interest will then be calculated based on this new principal amount, $49,208.33 and every month you will be reducing your principal amount.
Second month housing loan interest:
$49,208.33 X 5% / 12
$205.03 (Second Month)
Let’s do the math by yourself using excel or use the following housing loan calculated, that you’re will end-up to pay $943.56 monthly and the total interest paid is $6613.70
Total car loan interest rate:
$6613.70 / $50K X 100%
13.23% (Total Housing Loan Interest Rate)
Car Loan
On the other hand, you have car loan of $50K at the interest rate of 5% for 5 years term.
1 year car loan interest:
$50K X 5%
$2,500. (Yearly)
First month car loan interest:
$2,500 / 12
$208.33 (First Month)
The only difference between the housing loan versus car loan is the car loan interest rate is fixed for every month. Therefore:
First month car loan interest:
$2,500 / 12
$208.33 (Second Month)
Let’s do the math again and the total amount that you want to pay including the interest for the entire loan is ($50K + $2,500 X 5 years) = $62,500 and monthly payment will be ($62,500 / 5 / 12) = $1,041.66
Total car loan interest rate:
($2500 X 5 years) / $50K X 100%
25% (Total Car Loan Intereset)
As you can see the car loan interest is 1.9 X higher than housing loan interest (i.e. 12.23% X 1.9 = ~25%)
Conclusion
Because the car loan does not reduce the principal amount and the interest is fixed through the year, therefore the interest is higher than the normal housing loan interest calculation provided the interest rates are the same.
So usually what people do when they have housing loan is try to reduce the principal amount as early as possible either by flexible-loan package or early extra payment. It doesn't work for car loan because the interest is fixed and the total interest that your are going to pay is 1.9 X higher than housing loan interest.
You may also want to know that the car value is depreciating every year after you buy it. Think of it, is this making sense to buy a car or house?
