Get a ‘simple’ not an ‘add-on’ loan

Pen on loan application papers

Most car loans are simple interest loans. You make the same payment each month, with part of the money paying the interest and part paying back the principal you borrowed.

The key thing about simple interest loans is that you only pay interest on the monthly balance, which is constantly being reduced. And there's usually no penalty for paying the loan off early.

But if you're not careful, some dealers will try to make a little extra money on your sale by signing you up for an add-on loan.

They require you to pay interest on the full amount you borrow for the entire term of the loan. That interest is "added on" to the principal and the sum divided into an equal number of monthly payments.

If it's a five-year loan for example, then the total would be divided by 60. Some of that interest is refunded if you pay the loan off early. But lenders often keep 20% of that refund as a prepayment penalty.

So when you sit down with the finance manager, always ask whether you're getting a simple loan.