About this video
Using a $10,000 car loan, the video shows how the loan term and interest rate change the total you pay. At 5% over 60 months the payment is $188.71 and interest is $1,322.60; stretching to 120 months lowers the payment to $106.07 but interest roughly doubles to $2,728.40; at 10% over 120 months interest jumps to $5,858. The lesson: keep terms short when rates are high and get your rate down, helped by a good credit rating.
You'll be able to
- calculate total paid and total interest from a monthly payment and number of months.
- explain why a longer loan term usually means more total interest.
- explain how a higher interest rate increases the cost of a loan.
- explain why a good credit rating helps.
Key words
- principal
- The amount of money you actually borrow. (The video spells it "principle".)
- interest rate
- The percentage a lender charges you for borrowing money.
- loan term
- How long you have to pay back a loan, such as 60 or 120 months.
- monthly payment
- The fixed amount you pay each month toward the loan.
- credit rating
- A measure of how reliable you are at repaying, which affects the rates you're offered.
Transcript
- [Narrator] The goal of this video is for you to appreciate how much interest and the interest rate can affect how much you pay over time. And also, how long it takes you to pay it off. So let's say you were to go out there, get a car loan, say for $10,000. So people would call that the principle.
That's the amount that you're actually borrowing. And let's imagine that the interest rate, let's start with a lower interest rate, let's say 5%. And let's say you do this over five years, but I'm gonna say that in terms of months, 60 months. So we can see here that our monthly payment is $188.71.
So let's think about the total that we pay. $188.71 times 60 months is going to give me $11,322.60. So I paid back that $10,000 in principle, plus I paid another $1,322.60. That $1,322.60, that is an interest. Now, what if I were to increase the loan term? So instead of paying it off in five years, if I were to pay it off in 10 years?
So that would be 120 months. Well, it seems tempting. Our payment just went down by a lot. It's a much smaller monthly payment. But let's look at how much we're paying in total. So 120 months, 10 years, times $106.07, our interest has gone up dramatically. We're now paying $2,728.40 more than our principle.
So it almost roughly, give or take, doubled it, when we doubled the term. Similarly, what do you think is going to happen when we double the interest rate here? So if we go from a 5% interest rate to a 10% interest rate, well now all of a sudden, our monthly payment has gone up, and it really adds up when you look at $132.15 times 120 months.
Now we're paying $5,858 more than the principle amount. So hopefully this little exercise has helped make clear that even though it might be tempting to pay things off over a longer period of time, you are paying a lot more interest. And it's also important to get that interest rate down as much as possible.
Compare interest rates, and especially if you're paying a high interest rate, then keep that term down, how long you actually have to pay down that loan, pay it off as quickly as possible. And the one good way to get a lower interest rate is to have a good credit rating, which we talked about in other videos.
Video © Khan Academy, used under CC BY-NC-SA. Watch on Khan Academy. Puzzicle is not affiliated with Khan Academy.