RV Loan Disaster – Difference Between Compounding Interest and Non-Compounding Rate

I had a friend the other day telling me how excited he was that he got a loan for his RV when he had been looking for a way to finance his motorhome in the spring of 2009. He had been researching and browsing the Internet and his local banks, lending institutions, and credit unions for some help with his loan. Unfortunately there was a big problem with the kind of financing he finally managed to get.

When I read the small print of his loan agreement I noticed that he was paying compound interest which is short for getting bent over a barrel – so to speak. For this article I would like to use the exact principal amount of his RV loan and calculate his interest over the term of his financing using both compounding and non-compounding interest rate formulas.

The first thing we should calculate is the better option using a non-compounding interest rate on this particular RV loan. The principal of the loan after his down payment was $ 55,000 approx. The like loan was for 20 years, the APR (interest rate) was 7.2%, and was was going to be paying every 30 days or once a month if you prefer. So let's do the calculation for this loan using this data;

Principal amount = $ 55,000

Length of loan = 20 years

APR = 7.2%

Payments at the beginning of each month

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RV Loan Calculation Results Non-compounding

Total Amount to be paid: $ 94,762.89

Total amount of interest $ 39,762.89

Payments: $ 389.44

So you can see above the total amount to be paid over the 20-year term of this loan on his RV would be just under $ 95,000 with the total interest being just under $ 40,000 and his payments just under $ 400 every month once a month. The key number here is the total amount of interest for $ 39,762.89.

Now let us use a completely different calculation using a compound interest rate with is exactly the same lending parameters as the first example using a non-compounding formula. Keep in mind that we will be using the typical compounding rate table as below;

Interest Rate Compounding at;

1 = .08

2 = .17

3 = .25

4 = .33

5 = .42

6 = .50

7 = .58

8 = .67

9 = .75

10 = .83

11 = .92

Principal amount = $ 55,000

Length of loan = 20 years

APR = 7.2%

Payments at the beginning of each month

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Total Monies to be paid over 20 years = $ 220,931.88

Total Interest to be paid over 20 years = $ 165,931.88

Notice the drastic difference between the total amount paid in the total interest paid using the different formulas. With a non-compounding loan he is only spending $ 40,000 in interest over the 20 years, while he is paying over $ 165,000 in interest using a typical compound interest rate. This is four times as much interest. This is typical if you are buying a house or property with a long-term mortgage of 25 years or 30 years, but certainly not something you should be doing with the vehicle (or a RV loan as in this example).

So be sure to follow through with your due diligence and read all the fine print in the lending agreement. Usually when you buy most vehicles you will not be asked to be involved with compound interest rate like this one, but sometimes if you signed onto a long-term loan of 20 to 30 years for a motorhome the lending institution may try to use a compounding interest rate because your RV is now considered your home. You need to watch out for this tricky little maneuver.

If for some reason you have signed onto your motorhome loan using a compound in interest rate, you must see if there is a penalty applied to pay off your loan in a lump sum and go to a different bank, borrow what you need, and start over with a non-compounding interest rate.

Source by Brent Truitt