Increasing your auto loan payment doesn’t seem like a good idea. But you’ll thank yourself later when the effects start to show, just like getting up early to go to the gym.
In this guide, we find out What Is Principal Payment On Car Loan, do large principal payments reduce monthly payments car loan, if i pay off the principal does the interest disappear, and how do i pay the principal on my car loan.
Paying more toward the principal of your auto loan is one of the best exercises you can do to improve your financial situation. Interest and principal are both included in each auto loan payment. How much interest you’ll pay over the course of the loan term should be specified in the loan agreement for your car.
It’s acceptable to pay more even though you shouldn’t pay less than what you agreed to for the loan. Like that 5 a.m. run, it’s for your own benefit. Less interest will accrue over the course of your loan if you pay off the amount more quickly. You’ll keep more money in your bank account and get your car paid off sooner.
What Is Principal Payment On Car Loan
What is the principal of the loan?
The sum you borrowed to pay for the car is known as the loan principle. The cost of the vehicle, any dealer costs, and any tax, title, and licensing (TTL) fees you might have financed are all included in that sum. When buying a car, you can reduce the loan principal by:
utilizing manufacturer or dealer incentives, or
purchasing a less costly vehicle.
Just one component of your payment is the principle. The annual percentage rate, or APR, is the other component. This includes the annual percentage rate (APR) and any extra expenses related to the loan. Principal and interest will both be included in your auto payment.
You will pay more interest than principal in the early stages of the loan period. More of the payment is applied to principle as time passes. There won’t be much interest left in the final few payments; they’ll primarily be principle.
The amount of principal and interest you are required to pay over the course of the loan will be disclosed in the Truth in Lending statement on your loan documents.
Principal reduction as opposed to interest reduction
The majority of auto loans are simple interest loans, meaning the interest rate is determined by the principle balance of the loan. Over the course of the loan, the payment is fixed. But each month, a different sum of money will be used to cover the principal and interest. As the interest is computed each month, it will decrease if you pay off the principal more quickly than required by the loan arrangement.
The principal and interest components of each payment are broken down in an amortization schedule that your finance firm may have provided. To find out how much interest you could save, use the amortization schedule or LendingTree’s automobile affordability calculator.
Here are the first and last installments for a $745.72 payment with a 60-month term and a 4.5% interest rate as an illustration:
By making additional payments toward the principal, you can pay off your auto loan sooner and accrue less interest. Since the interest is based on the principal balance, it is most efficient if you can pay off the principal early in the loan term.
Find out how extra payments will be handled from your lender. Except when you specifically want to pay down the principal, some lenders will apply them to the subsequent payment. In that situation, the principle may or may not be paid off faster while you may or may not owe less on the subsequent month’s payment. Lenders may have unique guidelines for principal-only payments.
If you have a loan with precalculated interest, the interest is determined at the start of the loan. If you pay any additional principle, it won’t alter. Before you begin making additional payments, make sure you are aware of the type of loan you have.
Why contribute more to the principal?
The main benefit of making extra payments on your auto loan is obvious: You can save money. Over the course of the loan, paying more toward the principal will result in interest savings.
If you want to sell the vehicle or trade it in, you might want to pay off your loan faster to increase the equity you have in the vehicle. Alternately, you could free up money for another use. However, paying extra on the principal wouldn’t make much financial sense if you have a low incentive APR, such as 0% or 0.9% financing.
How to pay interest just on the principle
Before making further payments, enquire about your lender’s policies on principal-only payments. For additional principle payments, certain lenders offer specific processes or payment gateways. Naturally, your account needs to be up to date. Any additional payment will be applied to catching up the account if you are in arrears.
There are a number of ways to use extra cash to pay off your car loan more quickly:
Your loan will be paid off a year earlier if you can consistently make payments as if you had a 60-month payment schedule. For instance, a $40,000 loan at 5% interest over 72 months would require a $644 monthly payment. The identical loan would require a $755 payment over 60 months, but you would save $1,091 in interest overall.
do large principal payments reduce monthly payments car loan
Buying a car is a huge milestone and commitment, and the sheer cost of a vehicle typically requires taking out a car loan you’ll repay over time with interest. You generally pay auto loans back in equal monthly installments over the duration of the car loan terms. Several factors affect the amount of this monthly payment, and once it’s set in stone, not much can change it.
Paying principal is a great way to pay off your car loan faster, but it won’t usually affect your monthly payment expectations. Your loan will remain on the same fixed payment schedule unless you refinance.
Paying off the principal faster than expected, however, could reduce your overall car loan term without changing the monthly payments. It would take fewer total months to pay off what you owe.
Paying principal comes with advantages and disadvantages. While it’ll never decrease your required monthly payment, the benefits it does offer might be worthwhile depending on your financial circumstances. Learn everything you need to know about paying the principal on your car loan.
What Is Principal on an Auto Loan?
The principal on an auto loan or any other loan is the amount of money you borrowed. For a car loan, it’s the amount you borrowed to purchase the car. This includes the price of the car itself as well as fees and taxes included with the purchase. Any money you borrow to cover the purchase of the car is part of the principal.
Put simply, the principal on your car loan is any part of your loan that isn’t interest. The annual percentage rate is the only aspect of your loan separate from the principal, and your loan payments cover both the principal and the APR.
Generally speaking, most car loans require you to pay off a lot of the interest first, with the principal being covered closer to the end of your car loan term, regardless of your credit score. The amounts for both will be clearly noted on your car loan documents.
Lowering Principal
Before you think about paying off the principal of any loan early, try to get that number as low as possible so you have less to pay interest on. You can take several steps to reduce the principal from the outset.
Put Extra Money Down
The down payment on a vehicle goes directly toward the vehicle, which is part of the principal. The larger your down payment, the less principal you’ll have to pay.
Cover the Taxes
Car loans often include taxes and other fees for titles and licensing. You can pay these costs upfront to reduce your loan’s principal value.
Trade in an Old Car
In lieu of making a substantial down payment, you can trade in an older vehicle you own. You can then put the value of that vehicle toward the new one. With both a trade-in and money down, the amount remaining to pay off is significantly less.
Opt for a Cheaper Car
We all have dream cars, but it’s financially smarter to opt for the most affordable vehicle that still offers everything you want. A new sedan can be loaded with exciting features and still be more affordable than the speedy sports car with less interior space and fewer infotainment options.
Advantages of Paying off Principal
It’s important to recognize that paying off principal will not lower your monthly payments. In fact, it will mean you’re paying more each month. Putting extra money toward your car loan, however, offers some benefits.
Shorter Loan Terms
Paying extra payments toward the principal in your car loan will shorten the overall length of your loan. While you’ll be paying more every month, you’ll be paying the loan back for fewer months total. You’ll also build equity much faster.
Less Interest
With the car loan principal decreasing, total interest decreases, as well. Interest payments always decrease over the life of the loan, but paying off the principal with extra payments will cause the interest payments to reduce even faster.
Disadvantages of Making Principal-Only Payments
When paying principal-only payments on your car loan, be aware of a few downsides to determine whether this strategy makes financial sense for your situation.
Prepayment Penalties
Some lenders charge a prepayment penalty if you pay off the loan earlier than stated in your loan agreement. With these penalties, the potential savings you get from avoiding the extra interest are offset, rendering your efforts useless. Lenders do this to recoup potential losses on the interest they would’ve otherwise received.
High-Interest Debt
Paying off your auto loan faster isn’t nearly as important as paying off other high-interest debt you might have, such as a personal loan. Credit cards, for example, often have higher interest rates than auto loans, so that’s something you’ll want to prioritize. Essentially, principal-only payments are only feasible options for those who don’t have other outstanding debts that could get in the way.
How to Make Payments toward Principal
Every month, a portion of your loan payment goes toward the principal automatically. You’ll need to send extra to make additional principal-only payments. This is only applicable if you don’t have overdue payments. Any extra you pay while behind will automatically go toward bringing you back up to date. Check out some options you have for making principal-only payments:
Make an Extra Payment
Making an extra payment is a simple yet effective way to bring down your principal. Simply contact your loan company and tell them you’re going to make an additional payment toward the loan, provided your contract doesn’t include penalties for doing so. Even doing this once a year or at least once during the loan term is helpful.
Pretend Your Loan Term Is Shorter
Assume you have a 60-month loan. With all the information from your loan, you can use an auto loan calculator to determine what your monthly payments would be for a 48-month loan. If you can pay that, do so.
You’ll only be legally obligated to pay the minimum payment set in your 60-month contract, but you’ll be blazing through your loan at a speed that’ll have you done in 48 months. This also provides some breathing room in case you have an emergency payment come up elsewhere in your life.
Make Extra Half-Payments
While you’re only required to pay a once-monthly car payment, you can make bimonthly car payments if you like. An extra payment every two weeks doesn’t have to be equal to your required regular payment. Instead, strive for half-payments to make it less of a financial burden.
Chip Away
Chipping away at your balance is easy to do when you round up. For example, assume your monthly payment is $342.98. Round that up to $350 or even $400 and you’ll be chipping away steadily at your principal.
Pay off a Large Portion at Once
If you find yourself with extra cash, use it to pay off part of your principal in a lump-sum payment. Whether you got a bonus at work or a surprise inheritance, this is an effective way to cut down on your principal balance or potentially cover the entire thing.
How Can I Lower My Car Payment?
Paying off principal can potentially save you money, but it won’t lower the minimum payment per month expected by the loan company. One way you can lower your payment, however, is by refinancing your loan. In fact, certain circumstances might make it more fiscally responsible to refinance rather than try to pay off your principal.
Refinancing Basics
Refinancing your auto loan means replacing your existing loan with a new one. In this scenario, your original loan balance is paid off and you begin payments toward the new loan. This can result in a variety of benefits depending on your unique financial situation. Find out the benefits of refinancing:
Lower Interest Rates
If your credit has improved since you took out the original loan, you might be able to refinance for a lower APR. While this could reduce your payments, it could also help pay off your loan faster for around the same monthly payment, essentially functioning the same as making extra payments toward your principal.
The difference is you might be able to refinance at a lower interest rate while also making extra payments toward your principal, which drastically decreases the overall loan term.
if i pay off the principal does the interest disappear
When you make payments on a personal or business loan, you’re actually paying two discrete things: loan interest, and loan principal.
Here’s a quick rundown of what those terms mean, and how to account for them in your business.
What is loan principal?
Loan principal is the amount of debt you owe, while interest is what the lender charges you to borrow the money. Interest is usually a percentage of the loan’s principal balance.
Either your loan amortization schedule or your monthly loan statement will show you a breakdown of your principal balance, how much of each payment will go toward principal, and how much will go toward interest.
When you make loan payments, you’re making interest payments first; the the remainder goes toward the principal. The next month, the interest charge is based on the outstanding principal balance. If it’s a big one (like a mortgage loan or student loans) the interest might be front-loaded so your payments are 90% interest, 10% principal, and then toward the end of the term, your payments are 10% interest and 90% principal.
To illustrate, let’s say Hannah’s Hand-Made Hammocks borrows $10,000 at a 6% fixed interest rate in July. Hannah will repay the loan in monthly installments of $193 over a five-year term. Here’s a look at how Hannah’s loan principal would go down over the first couple months of the loan.
As you can see from the illustration, each month, the 6% interest rate applies only to the outstanding principal. As Hannah continues making payments and paying down the original loan amount, more of the payment goes toward principal each month. The lower your principal balance, the less interest you’ll be charged.
Accounting for loan principal
A common mistake when accounting for loans is to record the entire monthly payment as an expense, rather than booking the initial loan as a liability and then booking the subsequent payments as:
partly a reduction in the principal balance, and
To illustrate, let’s return to Hannah’s $10,000 loan. When Hannah takes out the loan and receives the cash, the entry on her books would be as follows:
Hannah’s first loan payment in August should be recorded as follows:
The $143 reduces the liability for the loan on Hannah’s Hand-Made Hammocks’s balance sheet, the $50 will be an expense on its Profit and Loss Statement, and the credit to cash reflects the payment coming out of Hannah’s Hand-Made Hammocks’s checking account.
If Hannah booked the original amount as a liability, but then booked each $193 monthly payment as an expense of the life of the loan, at the end of each year, Hannah’s liabilities would be overstated on its balance sheet, and its expenses would be overstated on its Profit and Loss Statement. If the error isn’t corrected before Hannah prepares her business tax return, the company might underpay the tax it owes for that year. If her bank wanted to see financial statements before approving another loan application or renewing a line of credit, the overstated liability might negatively impact the bank’s decision.
How to pay off loan principal faster
If you’re getting depressed thinking about how much interest you’re actually paying, there’s good news: Most lenders let you make additional principal payments to pay off a loan faster. Making extra principal payments will reduce the amount of interest you’ll pay over the life of a loan since interest is calculated on the outstanding loan balance.
For example, if Hannah pays an additional $100 toward the loan’s principal with each monthly payment, she will reduce the amount of interest she pays over the life of the loan by $609 and shorten the five-year loan term by almost two years.
If you want to pay your loan off early, talk to your lender, credit card provider, or loan servicer to find out how the lender applies extra payments. Some lenders automatically apply any extra payments to interest first, rather than applying them to the principal. Other lenders may charge a penalty for paying off the loan early, so call your lender to ask how you can make a principal-only payment before making extra payments.
This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. Bench assumes no liability for actions taken in reliance upon the information contained herein.
how do i pay the principal on my car loan
The process of paying down loan principal ahead of schedule isn’t always straightforward.
You’ve probably seen the terms “loan principal” or “loan principal balance” floating around on your car loan statement. Whether you’re motivated to pay off your loan early or you’re considering a car loan refinance, these numbers are important: They tell you how much you initially borrowed and how much you have left to repay.
Paying off your loan principal balance isn’t always as simple as writing a check, mailing it to your lender, and saying sayonara to the loan forever. Fine print and fees can potentially throw a wrench in your plans. In this post, we demystify how car loan principal works, how interest affects it, and some roadblocks you might run into if you try to pay it off early.
What Is Car Loan Principal?
Loan principal is the amount you originally borrowed from the lender for your car. Say you buy a car that costs $25,000 (including taxes, title, and fees) and you put down $5,000. Your loan principal at the start of the loan term would be $20,000.
But the $20,000 in initial loan principal isn’t all that you owe because borrowing money isn’t free. Lenders tack on an interest rate to your loan which is how they make money.
How Does Interest Work on Car Loans?
Lenders may charge simple interest or precomputed interest on car loans. Here’s how both of these work:
Banks and credit unions tend to charge simple interest for car loans and not compound interest or precomputed interest.
Compound interest is when interest is charged on your principal balance and the accrued interest — basically, it’s a double whammy. Interest compounding on a savings account is a good thing because your accrued interest earns interest. Interest compounding on a loan is not so good — it means the interest you owe builds upon itself.
You may also see interest expressed as a percentage alone or a percentage with the three letters APR at the end. The interest rate by itself is the percentage you pay annually for the money you borrow. APR stands for annual percentage rate, and takes into account how much you pay for the amount you borrowed plus any applicable loan fees. Usually, the APR percentage is higher than the interest rate.
How Does Interest Affect the Principal Balance?
Part of your monthly payment goes to paying down your principal, while the other portion (sometimes a large portion) gets applied to interest. Because of this, you may notice that your principal balance doesn’t seem to move much at the beginning of your loan term despite you making payments.
Lenders typically use an amortization payment schedule for car loans that distributes a larger portion of your payments to interest at first. As you get closer to the end of your loan term, more of your monthly payment will go towards paying off the principal balance. If your lender charges you a simple interest rate, paying off some of your principal ahead of schedule can result in interest savings.
Can I Pay Down Loan Principal Early?
Yes, it’s possible to pay down the loan principal early, and there are several reasons why you may want to do so. Perhaps you have a 72- or 84-month loan term and you’re worried about depreciation or you recently got a raise at work — paying down the loan principal can keep your car above water and it can help you pay off the loan faster.
However, the process of paying your car off is not as easy as sending a few extra loan payments. First off, the type of interest you have (whether simple or precomputed) matters.
If your lender charges simple interest, making advanced payments can reduce the interest you pay, but you need to make sure your extra payments are allocated to the right place. If you don’t request that payments go directly to the principal, the lender may still allocate the money to interest payments.
You also need to watch out for the fine print. Some lenders may charge a prepayment penalty fee if you pay the loan off early. You’ll see the fee (typically a percentage of the balance or precomputed interest) in your Truth in Lending statement. This fee can eat into the interest savings you see from making additional payments.
If you have a car loan with precomputed interest, the interest is precalculated and stays the same even if you make extra payments. In this scenario, you don’t get rewarded with interest savings for lowering your balance ahead of schedule.