Car Loan

Have you ever asked youself why wealthy people do not use debt as nearly as we are led to believe? Well, some say debt is dumb.

You are buying a car and thinking of taking a one-year loan of $1,000. Your APR of 12% per year (or 1% a month) is to be repaid in 12 months or 12 equal monthly payments. The monthly payment is $88.85.

The salesperson trying to sell you a car makes the following statement:
"Although the rate on this loan is 12% per year, it worked out to be a much lower rate. Because, the total interest payments over the year are only $66.19 and the loan is for $1,000, you will be only paying a true interest rate of 6.62% oer year."

What is the trick here?

The trick is here that with your first monthly payment, you are paying not only interest on the outstanding balance, you are also repaying part of the principal. The interest payment due at the end of the first month is 1% of $1,000 or $10. Because your monthly payment is $88.85, the other $78.85 is repayment of principal.