Saturday, March 21, 2009

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?

31 Comments:

Michael Tsen said...

Car is the biggest killer in one's personal finance planning and you can use a rule of thumb that car loan rate is 1.9X more than house loan Hope these 2 posts help too....

ChampDog said...

I like the idea of the rule of thumb car loan interest is X1.9 higher than the house loan. I will update the blog to reflect that. :)

Gopal. G (Gkannan) said...

Good post, but a more practical idea is to get rid of the not-so-essential cars. This is the current thinking in these days of recession, which is likely go deeper further in the coming days.

ChampDog said...

I absolutely agree with that...

forex-tiwisue said...

Good sharing but think about it, no car = no transport. No transport = less sales, less networking. Less sales, less networking = less income (unless one is full-time e-commerce). Less income = no money to buy a house. In my very humble viewpoint, this is inter-related. Nothing is worthy or unworthy, we are depending each and another to live.

ChampDog said...

I think we still need a car unless some of the countries where the transportation is even more convenient that you driving (e.g. Singapore), then you can get rid of car.

If using car is necessity, I think we should go for it. If you buy the car for the right purpose, it is okay. But if you buy for the hobby purpose, you may want to think about it.

loan modification said...

nice post. thanks for sharing.

imDavidLee said...

last time i paln to buy house for renting purpose, but after i calculate, i feel that not so worth to do that since alot of fees like sinking fund, maintenance fees, eletrical bills, fire insurance, indrawater add up will equal to rental fees...

sam said...

ok

ChampDog said...

@David, perhaps the good thing is at the end you own the house. The location of the house is also very important to determine the renting price... :)

plin said...

Very nice post. Thanks for sharing.

So what happens when you prepay additional amount to your car loan? Effectively the only way to save on car loan is to pay off the entire amount?

ChampDog said...

I think nothing will happen if you pay additional amount for your monthly car loan instalment. Probably, next month, you can pay less BUT in terms of the interest, you will still pay the same. Unlike housing loan, you can pay additional $ to reduce principle thus reducing the interest...

Yupe, in general if you can buy the car with cash or afford to take 1-2 years loan, then you can go for it. However in some cases, some companies have a benefit to their employee to help them pay up 50% of the interest or pay certain fixed amount of interest (depends on the benefits and compensation of a company), you can make use of it by taking longer loan.

Anonymous said...

principal, not ptinciple

ChampDog said...

Good catch! Corrected already, thank you. :)

yin liNg said...

can i know why there's a difference between the calculation of housing loan and car loan? thanks...

ChampDog said...

Good question! But I honestly do not know the answer. Anyone wants to help? I'm interested to know the answer too. :)

Car Loan said...

Nice blog. Thanks for the information here. It helps me to calculate car loan interest.

Devin said...

Brilliant post. To me this are some mind blowing facts.
In Malaysia, we need a car to sustain our daily drive.
In my case, my income is good enough to buy a Honda city with 5 years loan but instead of that I bought saga Fl for 2 years loan. I save nearly 8000 in terms of interest.
Age factor also important. Im 27 now and I have good enough planning to buy accord by 32 with short term loan. Of course my big chunk of income goes for various type of investment.
Merely my 2 cents guys.

ChampDog said...

Nice one Devin. Thanks for the sharing and tips! :) Sometimes see whether you want to give up the "Symbol" of "Wealth". hahaha....

Devin said...

Yes, its true what you commented.
I was pretty much confused with these factor actually. Then, i made up my mind to live for myself rather than living out our life in order to fulfill people view.

nagarajan said...

Instead of buying home i will got to car. Because compare to home loan amount i will be free from other charges like maintenance. Because nowadays we can pay the maintenance money as an car loan emi that much of amount they are collecting it as an maintenance :(

ChampDog said...

It is 2 different things. Your home maintenance fee is the service that you pay for and you enjoy it. You don't compare to that with the car loan interest. If you don't want such services, you can always buy the house or home that without any maintenance fees.

But I agree with you that when you buy property, we should always consider carefully whether such maintenance fee is worth for the services. I personally do not prefer super expensive maintenance fee property.

esurance Review said...

This will make loans trough car finance transparent.

Car Finance said...

I liked the way you have shared the information. Very well described about the loans.

ChampDog said...

Thanks! :)

Allan Belville said...

Hi there, is this exact blog is your sole site or you in addition to that own some more?

ChampDog said...

I have few other more blogs. :)

Claire Byrnes said...

There's no doubt that we tend to always want a car or truck unless of course a lot of the states when the vehicles is normally actually easier that you really traveling after that you can shed car.

However,if by means of automobile is normally prerequisite, There's no doubt that provide go with it. If you opt for your car for the best goal, it really is okay. Still if you decide on with the craft goal, you might contemplate it.

ChampDog said...

Yupe, no right or wrong as long as we are clear on what we really want. :)

Eric Nicole said...

Many banks provide users loan calculators on their websites with which to better understand how personal loans work. You can enter the loan amount you are looking for and the tenor of the loan and the Calculator will help you determine the probable monthly repayment installment amount.

ChampDog said...

Maybe I"m from engineering background - in my opinion, we should always know exactly how those calculations work before start using the calculator. So you won't blindly trust the calculator. Also, I think it is a good practice for personal finance. Many people are weak in personal fiance mainly because they don't know how to calculate. Anyway, this is must my 2 cents.


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