Main content
Monthly payment versus total cost
Choosing the smallest monthly payment for your car loan might seem like a good deal at first, but it usually means you'll end up paying a lot more in interest over time. Plus, it could put you in a spot where you owe more than what the car is actually worth, making it hard if you want to sell or trade it in later. Created by Sal Khan.
Video transcript
- [Instructor] In this video, we're going to explore the trade-off between trying to lower
our monthly payment while also trying to lower the total amount of money we pay out to get a loan for a car in this scenario, although this trade-off is
true for many types of loans. So let's say we are buying a car. We're putting some money down, but then we have to borrow the rest, and let's say we have to borrow $15,000 in order to buy this car. Now what this table shows
us is different terms. So if we wanted to pay
this off over 36 months, which is three years, four
years, five years, or six years. Now what's interesting is, depending on the length of the term, the interest rate is likely to change. It's likely to be higher
for longer term loans when you pay it off over
a longer period of time, and generally that's because the person lending you the
money is taking on more risk if it's gonna take longer for
them to get their money back. So here we're assuming
that the lender's willing to give you 6% loan for 36 or 48 months, but then it goes up to
7% for 60 or 72 months. Now, based on these, you
could use a payment calculator to come up with these numbers. These are the monthly payments we get. Now, as you would expect,
the longer the loan term, the longer it's taking
you to pay things off, you do see a trend that your
monthly payment goes down. It goes down if you're
paying it off in three years. It's $456. If you're paying it off in six years, so twice the amount of time, it doesn't quite go to
half, but it's a lot lower. 250, almost $256 a year. But here's the catch. If we think about the total amount that we are paying back to the lender, when we do it over 36 months
with a 6% interest rate, the total amount that we
are paying back is $16,428. Or another way to think about it, in this scenario right over here, we paid back the $15,000, and then there's another $1,428
that we paid in interest. That's essentially how the
lender makes their money. So that's what we paid back over there. But look what we're paying
back in this six-year scenario. For that same $15,000
loan, we pay that back, plus we pay another
$3,400, $3,413 in interest. Even though the interest rate
is only a little bit more, we're paying that interest rate over a longer period of time. So this is something
to really keep in mind. Now, as I've touched on in other videos, there's other reasons
why you want to go closer to the shorter end of
the spectrum over here. You definitely don't want
to end up in a scenario where your car depreciates so much, so you have to be careful, try to get a car with a good resale value. But there have definitely been scenarios where people get
upside-down on their loan, which means let's say
they got a six-year loan and five years have gone by
and they wanna sell that car, but the amount of money
they get for the car, the cash amount is actually less than
what they owe on a loan. You do not want to be in that scenario. There's also scenarios where
maybe you are in year five of a six-year loan, and obviously this is not a
scenario we want to be in, but let's say you get into a car accident. Your car gets totaled. The insurance company
doesn't care about your loan. In most cases, they're just gonna pay you the cash value of the car. If the loan amount is still pretty high, especially compared to that cash value, that probably isn't a good
financial situation to be in. And that's above and
beyond just the psychology of if you're able to pay it off sooner, you're able to be free and clear sooner and use that cash for other things.