I'm not sure where some of the people in this thread come up with this stuff. Ruprecht seems to be the one that really has it right (though he added in some info that the OP probably doesn't need to know).

For a standard auto loan, your interest is compounded monthly. Each month you pay off all of the interest that compounded that month, and the rest of your payment goes to paying off the principal. The bank has already run the numbers to make sure that the principal is paid off exactly at the end of your term (60 mos).

The interesting part is that if you pay just one extra payment up front, it can actually shorten the term of your loan by more than one payment. That's due to the fact that once you pay that extra principal up front, you no longer have to pay the interest on that amount for the next 60 months.

As an example, if you take out a 20K loan at 5.3% interest for 60 mos, your payments will be 380.18 per month. If you make a double payment (760.36) for your first payment, then you don't have to pay the 60th payment (since you paid it upfront), but your 59th payment will only be 267.78 (which is 112.40 less than it would've been if you hadn't made that additional payment). So, that's 112.40 in interest that you saved.

Google "payment calculator" and look for one that has an amortization table to see what's really happening (usually mortgage calculators will have this). You can play with the numbers to see the impact of paying a little extra each month (or as a one-time thing). There's a pretty good calculator on bankrate.com that allows you to add in one-time payments, or extra principal, etc, etc.

Edit: By the way, if you think your car loan is bad, wait till you get a home loan. On my primary mortgage, I've made over $27K in payments, but my principal has only decreased by ~8K. That's nineteen thousand dollars of pure interest.

 

Several have come close to explaining it but still have fallen short of the mark.

Basically there are 2 different types of car loans - 1) Simple interest loan like a home loan and 2) Add-on interest loans (rule of 78s).

1) The simple interest loans calculates the interest each month based upon the current principal balance. This means that any extra you pay is deducted before the new interest calculation and your loan will pay off in a shorter period of time.

2) The add-on interest loan adds all the interest in up front and interest is paid first.

How do you tell which one you've got? It's simple, look at your original loan amount. If it was much more than the amount you thought you were borrowing for the car then they added-on the interest to the note. So you have an add-on interest loan.

On both loans you will pay more interest than principal in the beginning years, BUT the add-on interest loan has you paying much more of your interest first. If you pay off an add-on interest loan in the first half of the term you will see a pay off amount that is lower than the balance. It could be quite a bit lower than the balance. But if you pay it off in the last half of the term your pay off balance may not drop at all since there is no unearned interest remaining in the balance.

On a simple interest loan your pay off balance is your present balance (plus any interest that may have accrued since you checked your balance). That means you don't get a lower pay off figure because you aren't paying any extra interest up front.

Cars and other consumer goods might have an add-on interest loan, homes always have simple interest loans.

A warning, the interest rate of an add-on interest rate loan may be lower than the simple interest loan and yet cost you much more. Always check the APR. That's why the govt. made them start showing you the APR.

Back in the day when they used to do add-on loans for homes banks would show you both loans and ask which one you want. They would give you an add-on loan for 7% or a simple interest loan for 10%.

Of course you'd choose the add-on interest loan but the APR on the add-on interest loan was actually 13+% whereas the APR on the simple interest loan would be 10.25% or so. Because so many people got burned the govt. started requiring APRs so that people could make informed decisions.

I didn't know about the 61 month thing on the add-on interest loans which I guess explains the proliferation of 60 month car loans.