Consumers are generally encouraged to pay extra money to reduce their debts and car loans. Before proceeding to make additional payments toward your car loan, it is important to consider a variety of factors, including your credit history, to ensure it makes sense.
Do Extra Payments Go to Principal?
In most cases, borrowers should expect that any extra amounts they pay toward their car loan will reduce the principal balance. This is a benefit that allows for paying the loan off faster and reduces the overall amount of interest paid over the term of the loan.
The majority of car loans are simple interest loans. Here, monthly interest payments are calculated relative to the amount of remaining principal that is outstanding at that time.
A portion of each monthly car payment is allocated between the principal and the interest on the loan. The principal is the total amount of money borrowed and the interest is the cost imposed by the lender who is executing the loan.
The amount of interest the borrower pays is calculated using the interest rate stated in the agreement. Interest is a standard applied and computed in different ways throughout consumer financing, which include credit cards, student loans, personal loans, and home mortgages.
During the early months of a simple interest loan, a larger part of each payment is applied to interest; therefore, making additional principal-only payments will reduce the overall amount of interest you pay.
Before making an additional payment on the debt, you should clarify how your lender treats extra payments and also confirm that you do have a simple interest loan rather than the much less common model of precomputed interest.
With precomputed interest loans, the agreement states that a fixed total amount of interest is paid regardless of whether the debt is paid off earlier, which clearly favors the lender.
Should You Pay Extra on Your Car Loan?
Except for home mortgages, cars are one of the largest purchases that consumers make. That’s why paying down debt associated with your vehicle is generally recommended.
Perhaps your income level has significantly improved since you originally secured the loan. The additional monthly income may allow for accelerating the repayment process.
Those who received an unforeseen employment bonus or a larger than expected tax refund may be better suited to make sizable “principal-only payments”.
Those with longer-term car loans, such as 60 to 72 months, may save large amounts of interest by paying extra. Often, borrowers choose extended term loans to secure lower monthly payments; however, substantial amounts of interest can accrue month after month.
Assess whether you have other debts with higher interest rates that should be prioritized. For example, credit card debts have roughly a 17% average interest rate compared to car loans, which average approximately 4%.
Remember to review the terms of your loan agreement for any applicable prepayment penalty. Some credit agreements have provisions that impose a prepayment penalty on the borrower for paying the loan off early.
For future vehicle purchases, strive to improve your credit score to obtain more favorable terms and interest rates. Commit to making timely payments, reducing your credit card balances, using a credit builder loan, or other strategies.
What is a good credit score to buy a car? The best auto loan rates are usually accessible only to those with a 700 or higher credit score.
Can you lease a car with bad credit? You can lease a vehicle with a credit score below 680. However, it becomes difficult to qualify for most leasing options and you should expect to pay more money upfront and have higher monthly payments.
How to Pay Extra Towards Your Car Loan Principal
Based on your circumstances, you might have options to choose how to pay extra towards your principal, such as paying off the entire loan balance at one time, making a one-time partial payment, or paying an additional ongoing monthly payment.
Next, you should confer with your lender regarding how to make sure the additional payment(s) apply toward the principal. For example, the additional payment to the principal may need to be made separately or otherwise designated or differentiated.
This clarification may be necessary to avoid confusion on the lender’s side, particularly if the account is set up on autopay or other similar automatic payments methods. Further, remember to review your loan statement to ensure the money was allocated as you had intended.
Another simple, yet less common option that might be possible for paying extra is to make biweekly payments. Here, you are paying half of the regular payment every two weeks, which serves to accelerate the process of paying off the loan.
By making biweekly payments, your lender receives what equates to 13 payments per year rather than 12. Put another way, every six months you actually pay 1.5 times the regular monthly payment and may result in significant savings when used on multi-year loans.
It’s important to avoid making extra principal payments if they are hindering your overall budget. For example, if you have little to no emergency savings, you might find yourself using high-interest credit cards for unexpected expenses, which is contrary to your goal.
How Can I Lower My Monthly Car Payment?
If you are suddenly unable to make your monthly payments, consider promptly speaking with your lender. The lender might be willing to temporarily defer your car payment and allow you to make additional monthly payments at the end of the loan term (or another arrangement).
Making additional principal payments will reduce the principal balance and long-term interest charges; however, the extra principal payments will not lower your ongoing monthly car loan payment amount.
Another option is to refinance your existing auto loan. Banks, credit unions, and other lenders will refinance your existing auto loan, which involves obtaining a new auto loan.
This refinance option may allow you to secure a lower interest rate loan that reduces your monthly car loan payments. Here, it is important to “shop around” to find the best auto loan rates and lowest finance charges.
Refinancing can save you considerable money if the car loan market’s interest rates have fallen or your personal credit score has risen since the time when you obtained the original car loan.
Another possible option is to sell or trade in your vehicle and acquire one with more affordable monthly payments.
Keep in mind that this option assumes you do not have negative equity, meaning the sale price or trade-in value is sufficient to pay off the remaining loan balance you owe.
FAQs
How Do I Make Sure Extra Payments Go to the Principal?
First, ensure that your car loan agreement is a simple interest loan that makes it possible to allocate additional payments to the principal. Although uncommon, precomputed interest auto loans exist that ensure the borrower pays a fixed amount of interest either way.
Review the terms of your agreement to determine if any prepayment penalties apply, which may somewhat hinder your goal of reducing the principal and interest payments. If you have uncertainty, speak with your lender for clarification.
Using a financial calculator will help you analyze the potential savings based on different payment scenarios.
Consider putting your desire to allocate extra payments to the principal in writing to the lender. Regularly review your loan statements to ensure your payments are divided according to your expectations.
What Happens If I Pay an Extra $100 a Month on My Car Loan?
Depending on the number of months remaining on your car loan, extra monthly payments can really add up. The following table helps to illustrate the potential savings that can be achieved by paying an extra $100 each month toward the principal over a 60-month term.
Making Extra Principal Payments to Reduce Interest Expenses
| Loan Amount | Loan Term | Interest Rate | MonthlyPayment | Extra Monthly Payment | Total Interest Paid | Loan Payoff Time |
| $ 20,000 | 60 months | 5 % | $377.42 | $ 0 | $ 2,645.52 | 60 months |
| $ 20,000 | 60 months | 5 % | $377.42 | $ 100 | $ 2,025.41 | 47 months |
Source: Auto Loan, Financial Calculator
Is It Better to Pay Extra on Principal or Interest on a Car Loan?
When possible, have any extra payments you make directed toward the principal on a car loan. This is inherently true because the principal is typically a fixed amount that doesn’t change; however, the interest you pay is dependent on the remaining principal.
As you pay down the principal, you will subsequently pay less interest. This is illustrated when looking at how a greater proportion of each monthly payment goes to the interest during the initial (early) months or years of the loan and then slopes downward.
When applicable, payments that are made on car loans typically are first applied to any remaining (due) fees and then applied to any due interest before being allocated to the principal.
Ultimately, making extra principal payments not only reduces your overall interest expenses but may allow you to pay the loan off faster. In the absence of the monthly car payment, you can redirect this portion of your income to other financial goals and priorities.
It’s important for consumers to comprehensively view and manage their finances and credit. Before making decisions, such as whether to make additional principal payments on a car loan, you should consider other debts, interest rates, retirement savings, and more.
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