Paying the Principal on a Car Loan
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. You might want to pay off your car loan faster if you want to sell it or trade it in so you build equity in the car. But if you have a low incentive APR like 0% or 0.9% financing, paying more on the principal wouldn’t make much financial sense. Interest rates vary based on the lender and your credit score, and, of course, general trends can affect the entire industry. If interest rates drop by 3 percent or so, that might be significant enough to save you hundreds on your total overall payments.
- Every payment that goes solely toward your principal builds equity in your car.
- Before rushing to do that, know that you may actually pay more overall, due to the extra months of interest.
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Essentially, your loan principal balance moves from one lender to another. Auto loan refinancing is taking out a loan with better loans to replace your old one. If you’re stuck in a loan with a not-so-great interest rate, for example, refinancing to a loan that has a lower interest rate can help you pay off the loan principal faster. This is because less money will go towards interest, and you can devote more money to attacking the principal balance.
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Refinancing is a good option if you are stuck with a loan that still has years left and does not want to be stuck paying for a vehicle that long. This requires higher monthly payments, but you will not be stuck with such a long term on your loan. If you’re looking for a way to lower your car payment, reduce the loan length, or cut back on interest, you might want to refinance your auto loan.
We believe everyone should be able to make financial decisions with confidence. 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.
If your bills are covered and you have a nice sum of money spare, paying your car loan off early means you’ll have one less bill to pay and it can save you money on interest charges. But before writing an extra check or wiring additional funds each month, you should speak with your lender to see if there are any early repayment “gotchas” that you should be aware of. When you’re paying extra toward the principal, you will pay off the car loan early and pay less interest. It’s most effective if you can pay down the principal early in the loan term because the interest is calculated on the principal balance. Lenders will always look at credit scores when deciding what kind of loan to give you.
Sell or trade your car
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Check your current terms to see if there are prepayment penalties, how many months remain on your existing loan, and your interest rate. You will typically benefit by refinancing to a lower interest rate if you have a high-interest rate with your current car loan. Make sure to watch out for any prepayment penalties with your existing loan. Paying that loan early, even if you’re refinancing, can trigger prepayment fees. When refinancing, one of the first things to consider is the loan’s term or length.
- Paying extra on your auto loan principal won’t decrease your monthly payment, but there are other benefits.
- Your loan consists of two segments, principal and interest, and there are different ways to approach paying them.
- If you’re looking for a way to lower your car payment, reduce the loan length, or cut back on interest, you might want to refinance your auto loan.
The loan agreement for your car should spell out how much interest you’ll pay over the loan term. 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. Paying down the principal on your car loan can be a good way to build equity. If your lender accepts additional principal payments, you can make one anytime you want. Some loans have prepayment penalties; if this is the case, you’ll be charged a fee for paying off your loan early.
How to make principal-only payments
She has extensive knowledge of various insurance lines, including car insurance and property insurance. Her byline has appeared in dozens of online finance publications, like The Balance, Investopedia, Reviews.com, Forbes, and Bankrate. 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.
It’s important to recognize that paying off principal will not lower your monthly payments. Putting extra money toward your car loan, however, offers some benefits. 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.
How paying down the principal on a car loan affects your credit
Paying off a loan early could impact your credit score, since any major change to your credit history can drop your score slightly. Also, you might prefer to keep your extra cash in hand for other uses, especially if your loan has a low APR. If your credit score has improved since you took out the original auto loan, you may qualify for a lower APR.
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. 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.
During the early part of the loan term, you will pay more interest than principal. The last few payments will be mostly principal with little interest left. This is the interest rate and other fees incurred for borrowing the money.
This is because your prepayment resulted in fewer interest payments going to the lender. They hope to recover some of that lost income by charging a prepayment penalty. Another benefit of paying down the principal is that you’ll save money over the life of the loan. This means if you had a 72-month car loan with a $15,000 balance at a 10.19% interest rate, securing 5.59% on a car refinance loan would reduce your monthly payment by $126.74. Some lenders will apply them to the next payment unless you specifically request to pay down the principal. In that case, you might owe less on the next month’s payment, but may or may not pay down the principal faster.
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Paying more on your car loan seems like the opposite of a good idea. But it’s like getting up early to hit the gym — you’ll thank yourself later when the results start to show. 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. 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.
If you can’t make principal-only payments, you may still be able to pay off your car loan ahead of schedule. Just make sure that your lender doesn’t charge prepayment penalties before making additional payments. If you can afford to pay more, you can apply it to your principal, but you still have a cushion if you cannot afford to pay extra. Most auto loans charge simple interest, computed by looking at the balance owed. You can reduce the balance owed by paying off the principal more quickly. This reduces the interest you pay throughout the loan, saving you money in the long run.