How to Calculate Per Diem on an Auto Loan
Understand and calculate the daily interest accrual on your auto loan to gain clear insight into your financing.
Understanding an auto loan involves more than just the monthly payment. A significant component is “per diem” interest, which accrues daily. Grasping this concept provides borrowers with a clearer picture of how payments are allocated and how the total loan cost is determined, empowering informed financial decisions.
Understanding Daily Interest on Auto Loans
Auto loans operate under a simple interest method, meaning interest is calculated only on the outstanding principal balance. This differs from compound interest, which calculates interest on both the principal and any accumulated interest. For auto loans, interest accrues continuously each day, even if payments are only made monthly.
The principal refers to the original amount of money borrowed for the vehicle. The interest rate is the percentage charged by the lender for the use of this borrowed money. The annual percentage rate (APR) represents the yearly cost of the loan, including the interest rate and any additional fees.
Interest accrues daily on an auto loan. Every day, a small amount of interest is added to the loan based on the remaining principal. This daily accrual ensures the borrower pays interest for every day the money is owed, regardless of the payment schedule.
As the loan term progresses and principal payments are made, the outstanding balance decreases. This reduction in principal directly impacts the amount of interest that accrues daily, leading to lower interest charges over time. This highlights the advantage of reducing the principal balance whenever possible.
Calculating Daily Interest for Auto Loans
Calculating daily interest on an auto loan involves converting the annual interest rate into a daily figure and applying it to the current principal. This calculation illustrates how much interest is generated each day the loan remains outstanding.
The first step involves converting the annual interest rate, or APR, into a daily rate. To do this, divide the APR (expressed as a decimal) by 365, the number of days in a year. For instance, if an auto loan has an APR of 6.5%, you would convert 6.5% to 0.065 and then divide 0.065 by 365, resulting in a daily interest rate of approximately 0.000178.
Next, identify the current outstanding principal balance of the auto loan. This is the portion of the original loan amount that has not yet been repaid. This balance decreases with each payment, as a portion is allocated to reduce the principal.
With the daily interest rate and the outstanding principal balance, the daily interest amount can be calculated. The formula is: Outstanding Principal Balance multiplied by the Daily Interest Rate equals Daily Interest. For example, if the outstanding principal balance is $20,000 and the daily interest rate is 0.000178, the daily interest would be $20,000 0.000178, which equals $3.56.
As the outstanding principal balance declines, the daily interest calculation on the reduced balance will yield a smaller daily interest amount. This means that in the early stages of a loan, a larger portion of each payment goes towards interest, while later payments allocate more towards reducing the principal.
Understanding this calculation highlights the financial benefit of making additional principal payments. By reducing the principal balance faster, borrowers can lower the overall interest paid over the life of the loan. Some lenders allow specific principal-only payments, which can further accelerate this process.