If you have a car loan, you’re required to make regular payments towards paying your loan off 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.
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 based on the total loan amount remaining on the day of your payment. If you choose to make an extra payment, the remaining loan amount will decrease. In turn, the total interest overall will also decrease.
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.
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. 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 or not these payments are permitted. Otherwise, speak with your lender to find out if a principal-only payment is allowed.
Once you get the green light, find out if there is a specific way that extra payments can be made. For instance, some lenders may allow deposits at bank branches, online payments, or even written cheques. In some cases, lenders may allow extra payments to be automatically applied to the principal balance of your loan.
How Extra Car Loan Payments Can Change Your Car Loan
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
Amortization Table: Car Loan Payment Without Extra Payments To Principal
In this example, 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 amongst 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||Beginning Balance||Interest||Principal||Ending Balance|
|1 Jan – Dec||$20,000.00||$1,196.99||$3,498.85||$16,501.11|
|2 Jan – Dec||$16,501.11||$962.66||$3,733.18||$12,767.89|
|3 Jan – Dec||$12,767.89||$712.64||$3,983.20||$8,784.64|
|4 Jan – Dec||$8,784.64||$445.87||$4,249.97||$4,534.64|
|5 Jan – Dec||$4,534.64||$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. Meaning, every six months, you’ll pay an extra $2,000. With these extra car loan payments, you’d pay off your loan in 2.5 years instead of 5 years and you’d save $1,553.59 in interest.
Amortization Table: Car Loan Changes With Extra Payments To Principal
|Year||Beginning Balance||Interest||Principal||Ending Balance|
|1 Jan – Dec||$20,000.00||$ 1,142.22||$ 5,553.62||$ 14,446.38|
|2 Jan – Dec||$16,501.11||$ 647.84||$ 8,048.00||$ 6,398.38|
|3 Jan – July||$12,767.89||$ 135.78||$ 6,398.38||$0.00|
|Total Paid||–||$ 1,925.84||–||–|
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 just a couple of 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.
Should You Make Extra Principal-Only Payments?
Before you make a principal-only payment, consider the following potential drawbacks first:
Early Repayment Penalty Fees
Some lenders charge penalties when borrowers repay their loans in full before the loan term is up. As mentioned, lenders make money off their loans from the interest they charge. If you repay your loan early, the lender will miss out on the profits they would have earned through interest payments during that period. To recoup their losses, they may charge a penalty fee for early loan repayment.
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. Some of these other debts may come with high-interest rates, especially credit cards. If you have other high-interest debts that you’re still paying, you may want to dedicate that extra chunk of money to pay these debts off first before making a principal-only payment on a lower-interest car loan.
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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:
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 need to borrow $20,000 to cover the cost of a $25,000 car after you’ve made a $5,000 down payment, this would be referred to as the principal.
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.
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.
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.
What Does It Mean To Refinance Your Car Loan?
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.
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.
Extra Principal-Only Car Payments FAQs
Is AIR the same as an APR?
Can I lower my car payments?
What are principal-only payments?
What’s better a simple interest car loan or a pre-computed car loan?
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.