The vast majority of car buyers take out loans to buy them, many lease, and few pay cash. (Guess which of these three funding methods is the only correct answer for the Financially Literate.) What many car loan contracts include is something called, “add-on interest.” You should never sign a contract that uses this term because you are charged interest twice and have no ability to save money by paying the loan off early.
A normal loan charges interest on the remaining balance of the loan. So the longer that you have had the loan and have been making payments, the more the outstanding balance decreases and your interest charges correspondingly decline as well. This is also called an amortizing mortgage where the outstanding balance declines as principal payments you make reduce the remaining balance on the loan. In contrast, an “add-on interest” loan adds the interest expense over the life of the loan onto the principal balance first and then spreads payments out over the term of the loan. The result of add-on interest is higher interest charges plus you cannot pay it off early because the loan balance includes interest charges.
When there are any unusual loan covenants or payoff schedules, you can be certain these benefit the lender and not the borrower. I know someone who tried to payoff one of these add-on loans early, and because of complications, she ended up with a lower credit rating because of add-on interest payment confusion with a regular loan. If you must use a loan to buy a car, when you shop around don’t forget to compare loan terms as well as the loan rate.