If you have a car loan, you’re required to make regular payments to pay off your loan over a certain time period.
Most lenders charge interest on their loans, which means you’ll need to repay the original loan amount, plus interest. As such, each payment you make will be split between principal and interest.
But what if you come across a little extra money and want to put it towards your loan? Is that possible? And if it is, can you dedicate 100% of that extra payment to the principal portion of your loan?
Let’s go into a little more detail about extra car loan payments and how they may help you pay off your loan sooner and save you money.
Key Points:
- If your car loan contract allows it, you can make extra payments strictly towards the principal at various intervals throughout your loan term.
- Making principal-only payments can help you save money on interest charges and even help you pay your loan off sooner.
- Options to put more money towards the principal include making lump sum payments, switching to bi-weekly payments, and rounding up your loan payments.
- Be sure to consult with your lender to find out what principal-only payment methods are allowed.
How Do Car Loan Payments Work?
There’s a lot more that goes into a car loan than just asking a lender for a lump sum of money. Let’s break down how car loans work and how your total amount owing is calculated to help you understand how much you’ll owe, and why:
Principal
The principal refers to the total amount borrowed to cover the cost of purchasing a car, less your down payment (if applicable). For instance, if you’re buying a $25,000 car and have $5,000 to put towards the down payment, you’d need to borrow the remaining $20,000 to cover the vehicle purchase. This $20,000 would be referred to as the principal.
Interest Rate
On top of the principal, you’ll also need to pay interest. This is how lenders make a profit on the loans they provide.
The amount you’ll need to pay will depend on how much you’re borrowing and the rate charged. The interest refers to the percentage of your principal that you must pay to borrow that loan amount. The higher the rate, the more expensive your loan will be.
Learn more: What Is The Average Car Loan Interest Rate In Canada?
Loan Term
The loan term refers to the amount of time you have to fully repay your car loan, including both principal and interest. Generally speaking, loan terms range from 24 to 84 months, though they could be shorter or longer in some cases.
A shorter loan term means you’ll need to pay the loan amount in less time. In this case, your monthly payments will be higher, but you’ll pay less interest overall. A longer term gives you more time to repay the loan and means your monthly payments will be lower. However, you’ll be paying more in interest over the loan term.
Learn more: How To Lower Your Car Payment
If I Pay Extra On My Car Loan, Does It Go To Principal?
Whether or not an extra lump sum payment on your car loan goes toward the principal portion depends on how (or when) the interest is calculated:
Simple Interest Car Loans
A simple interest loan means the interest you owe is solely based on the loan amount remaining on the day of your payment. Simple car loan interest is calculated on the payment due date.
So, as you continue to pay the loan off month after month, a decreasing amount of interest will make up each loan repayment. In turn, an increasing share of the monthly payments will go toward the principal.
| Example: Let’s say you take out a $20,000 car loan, with fixed monthly payments of $400. Each month, the total payment amount remains the same, but how much of it goes towards principal versus interest changes slightly: Month 1: Original loan amount of $20,000 = $100 interest; $250 principal Month 2: Remaining balance of $24,750 = $99 interest; $251 principal Month 3: Remaining balance of $24,499 = $98 interest; $252 principal This process continues until the full loan amount, plus interest, is repaid. |
If you choose to make an extra payment, the remaining loan amount will decrease. In turn, the total interest overall will also decrease.
Learn more: Is Your Monthly Car Payment Too Expensive?
Pre-Computed Interest Car Loans
A pre-computed car loan is a little more complicated. With this type of loan, the overall interest you’ll owe by the end of the loan term is pre-calculated, which means your total interest amount is already determined when you initially take out the loan. The total loan and interest will be divided into equal installments that you’ll need to pay.
More interest is allocated to the earlier payments, and as such, paying your loan off early in this case is less beneficial. Even if you make an extra payment, you’ll still need to pay the full interest amount that’s been pre-determined from the get-go.
| Example: Loan Amount: $20,000 Interest Rate: 5% Loan Term: 5 years Pre-computed Interest: $5,000 ($20,000 x 5%) Total Loan Amount: $25,000 ($20,000 in principal + $5,000 in interest) Regardless of whether you repay the loan off early, you’ll still need to repay a total of $25,000. The interest is already factored into the loan amount from the beginning. |
Use this car loan calculator to calculate your car loan payments.
How Do You Make Principal-Only Payments?
Before you make an extra payment towards your loan principal, you’ll first need to find out if you’re allowed to. Your loan contract should detail whether these payments are permitted. Otherwise, speak with your lender to find out if a principal-only payment is allowed.
These are the more common ways to make extra principal-only payments on a car loan:
- Lump Sum Payments: You may have the opportunity to apply a large sum of money to the principal to lower the balance and save on future interest.
- Bi-Weekly Payments: Rather than making monthly payments, you can make bi-weekly payments, which are half-payments every two weeks. This effectively adds an extra payment each year, which can help you repay the loan faster and cut down on interest costs.
- Round Ups: For each payment, you can round up your monthly payment to pay off the principal faster.
How Extra Car Loan Payments Can Change Your Car Loan
Extra payments toward the principal portion of your car loan can help you repay your loan sooner and save you a great deal of money in interest charges.
Below, we’ve illustrated how much extra payments can save you in interest and time. We’ve used a vehicle purchase price of $25,000 and a down payment of $5,000. In this case, you’d need to borrow $20,000.
Assuming a loan term of 60 months and an interest rate of 6.5%, the following chart displays how much you will pay in monthly payments and overall interest, as well as what your total loan cost will be:
Car Loan Payment Without Extra Payments To Principal
| Car Value | $25,000 |
| Down Payment | $5,000 |
| Loan Amount | $20,000 |
| Loan Term | 60 |
| Interest Rate | 6.5% |
| Monthly Payment | $391 |
| Total Paid | $28,479 |
| Total interest | $3,479 |
Amortization Table: Car Loan Payment Without Extra Payments To Principal
In this example, for every loan payment you make, your loan amount will decrease until the remaining balance is zero by the end of the loan term. But how that monthly payment is divided between interest and principal will continue to change. The share of your monthly payments going toward the interest portion will steadily decrease, while the share paid toward the principal portion will increase.
Here is an illustration of how your payments will be amortized and split between interest and principal on an annual basis:
| Year | Interest | Principal | Ending Balance |
| 1 Jan – Dec | $1,196.99 | $3,498.85 | $16,501.11 |
| 2 Jan – Dec | $962.66 | $3,733.18 | $12,767.89 |
| 3 Jan – Dec | $712.64 | $3,983.20 | $8,784.64 |
| 4 Jan – Dec | $445.87 | $4,249.97 | $4,534.64 |
| 5 Jan – Dec | $161.25 | $4,534.59 | $0.00 |
| Total Paid | $ 3,479.43 | – | – |
How Your Car Loan Changes With Extra Payments To Principal
Using the same example as above, you’d be paying a monthly payment of $391, which would go toward your principal and interest. However, here you’ll pay an extra $2,000 toward the principal semi-annually, or every six months.
Amortization Table: Car Loan Changes With Extra Payments To Principal
With these extra car loan payments, you’d pay off your loan in 2.5 years instead of 5 years, and you’d save $1,904.58 in interest.
| Year | Interest | Principal | Ending Balance |
| 1 Jan – Dec | $ 1,019.77 | $ 7,676.07 | $ 12,323.93 |
| 2 Jan – Dec | $ 505.69 | $ 8,190.15 | $ 4,133.78 |
| 3 Jan – July | $ 49.39 | $ 4,133.78 | $0.00 |
| Total Paid | $ 1,574.85 | – | – |
Advantages Of Making Extra Principal-Only Car Loan Payments
As long as your lender allows it, designating an extra payment as a principal-only payment means 100% of the money will go directly toward your principal. Here are the two main perks of making principal-only payments:
- Pay Off Your Loan Faster. Making a lump sum payment toward the principal means your original loan amount will decrease. As such, you can reach a balance of zero sooner and shorten the overall loan term.
- Save On Interest. Principal-only payments can reduce the total interest you pay over the life of the loan. By paying down the loan balance, the interest accrued on the balance also decreases.
Potential Drawbacks Of Extra Principal-Only Payments
Before you make a principal-only payment, consider the following potential drawbacks first:
- Early Repayment Penalty Fees: Not all auto loans can be repaid early. Some lenders charge penalties when borrowers repay their loans in full before the loan term is up.
- Less Money For Other High Interest Debts: If you have other debts besides your car loan payments, such as credit cards, rent/mortgage, and personal loans, you should ensure these are paid before putting any extra money towards your car loan.
Principal-Only Payments Vs. Refinancing
The point of a principal-only payment is ultimately to reduce your overall interest cost and potentially shorten your loan term. But you may also be able to save some money on your car loan by refinancing.
A car loan refinance means taking out a completely new loan and replacing the existing loan, ideally with better terms that will make the loan more affordable. Borrowers typically refinance to a lower interest rate or a different loan term.
Should You Refinance Your Car Loan Instead?
In your case, would it be better to refinance your existing car loan? Here are some reasons you should consider refinancing your car loan:
- You want to shorten or lengthen the loan term. Your current loan term may have been suitable when you first took out your car loan, but perhaps your financial situation has changed, which may warrant a modification of your loan term. In this case, you may want to refinance to a new term.
- To get a short term – If you want a shorter term, you can be loan-free sooner rather than later. Plus, you will be able to save a lot of money on interest over the life of the loan.
- To get a longer term – Alternatively, you may want a longer loan term to spread out the payments and reduce the amount you have to pay every billing period. While this will mean more interest paid over the life of the loan, the lower monthly payments might be easier for you to manage.
- You can get a lower interest rate – If you’re able to qualify for a lower interest rate compared to what you’re currently paying, refinancing might make sense. A lower rate will help you save a significant amount of money over the loan term. Verify all the expenses associated with refinancing your car loan to make sure the savings far outweigh the costs.
Final Thoughts
If you stumble upon a little extra cash, you may be able to make extra payments toward your car loan in addition to your regular installments. These payments typically go entirely toward the principal, which means you can whittle down your loan a little faster, and save some money at the same time. Just be sure there are no early repayment penalties involved that could cancel out any potential interest savings if you choose to pay off your loan early.
