Editor’s note: The following is part two of a two-part series on what to look for and ask when taking out a loan.

HOW IS THE INTEREST CALCULATED AND ACCRUED?

Interest can accrue in one of two ways, “reducing balance” or “add-on”.

If the answer is anything other than “reducing balance”, leave immediately. Reducing balance means that every payment you make reduces your principal and interest, and the next interest payment is calculated based on the now — lowered principal. Therefore, if you have a $100,000 principal, and have paid $20,000 of it already, any future interest will be calculated off the remaining $80,000.

With “add-on” the interest is calculated against the original principal amount, no matter how much of it you have paid off.

In the $100,000 loan example, even though the principal has been reduced to 80,000 through payments, interest would still be calculated at the original $100,000 until the loan is completely paid off. This is easily one of the worst loan types to take. Never take a loan with add-on interest terms. (Special shout-out to the Students’ Loan Bureau who offered their student loans with add-on interest till April 2016. I still haven’t forgiven you guys for that).

With regards to accrual, confirm if the interest is calculated and accrued every payment period (usually every month on your payment date). Most loans are like this, but just ask to be sure. Note, if the accrual period is shorter than your payment period, do not take that loan, go elsewhere. (eg if your loan payment is due monthly, interest should accrue monthly, not every two weeks or anything less than monthly)

CAN I MAKE EARLY PRINCIPAL PAYMENTS?

This is a major point. Early payments to the principal reduce how much interest you pay overall, because, as mentioned earlier, interest is calculated on the remaining amount. If you can make any extra payments to this at any time during the life of the loan, you will pay less interest overall.

Early principal payments are key to reducing debt. This is why some institutions don’t allow early payment (because they make less money offyou). Other institutions allow it, but make the process more difficult than regular payments. A loan I took once from a popular commercial bank could be paid online, but early principal payments required going into a branch.

I won’t say that you shouldn’t take a loan if it doesn’t allow this, because maybe all the other terms are extremely great and you had no intention of paying this loan off early — but I would be very wary of any institution that offered car loans but didn’t allow (or had a penalty) for early payments.

There are, of course, lots of other things to consider when taking a car loan (or any loan for that matter), but these are the things that top my personal “what-to-look-out-for” list. I’ll give you a quick summary of them again.

WHAT’S THE ANNUAL INTEREST RATE?

We need to know this to know how much we’ll be paying for the life of the loan. Lower is always better when it comes to loan interest rates. Shop around to make sure you’re getting the best deal possible.

CAN THE ANNUAL INTEREST RATE CHANGE?

If it can, you don’t want this loan.

HOW LONG IS THE LOAN FOR?

Get this in years and payment periods (usually months).

CAN I SEE AN AMORTISATION SCHEDULE PLEASE?

Don’t take any loan if they won’t give you a copy of this schedule. It should have all the information on the entire loan, including all payments.

HOW IS THE INTEREST CALCULATED AND ACCRUED?

It should be “reducing balance” and interest should accrue every month (or whatever your payment periods are). It should not accrue quicker than your payment periods.

CAN I MAKE EARLY PRINCIPAL PAYMENTS?

Yes, is best. Make sure there are no fees around early payment either. The more you put towards your principal, the less interest you pay in the future.

I hope these points were helpful. Till next time!

Randy Rowe is a strategy consultant and lead writer at www.everymickle.com. He is NOT an investment advisor. He knows a thing or two about loans from his own early experiences (pronounced “mistakes”) with loans. The most important tip he can give is to learn from the mistakes of others. You get all the learnings, with none of the blowbacks. You can save yourself a lot of headaches that way.