Using the above example of the $30,000 car with a $ monthly payment, let’s say that you made some extra money this month and want to pay $1,000 instead. That extra $ would be allocated to the balance of your loan, which is the principal. If you were making payments for a year with an outstanding balance of $24,469 per payday loans AZ the amortization table, the principal would be reduced to $24,.
Does Paying Down Principal on a Car Note Reduce Monthly Payments?
Even though a car note is a fixed payment, unlike credit cards which are revolving debt, you don’t have to wait until you have the full amount on hand to start paying it down early. Using the above example where the car note obligation is $ per month but you decide to pay $1,000 that month instead, your monthly payment will be reduced from that point forward. This is because the principal amount will have reset using the same interest rate, so less interest will accrue on the reduced principal.
An extra $50 or $100 towards the principal every month may not seem like a huge impact at first, but it becomes noticeable over time. Depending on the interest rate and how much you borrowed, and how far along you are in the life of the loan, you can end up drastically reducing your monthly payments to the point you can pay off the entire car sooner than you planned.
Is it Better to Make Principal-Only Payments?
It depends on the type of agreement you have with the lender. A principal-only payment can help propel your payoff date much faster, or if the lender has a punitive early repayment policy, it can end up defeating the purpose of paying off the loan before the end of its life.
Essentially, a principal-only payment that is separate from your regular monthly car payment goes directly to the principal of your car loan. Just like adding extra money to your regular car payment, principal-only payments can help you approach your payoff date faster while resulting in continually smaller monthly payments because that principal reduction causes the amortization schedule to recalculate.
However, every lender has different policies regarding these payments. There may be a pre-payment penalty specific to the type of loan you have, or that the lender applies to all of their car notes. A pre-payment penalty may or may not be worth making large principal-only payments since this is the lender’s way of getting back their lost income. Some lenders will meet you in the middle by putting a cap on principal-only payments before the penalty kicks in, others will discourage them altogether. Check the fine print of your loan’s terms to see if you would factor this into your plan to repay your car loan early.
Reducing your car loan’s principal will help you pay it off faster, but you should consider both pre-payment penalties and prioritizing paying down other debt with higher interest.
For example, a $30,000 car purchase with a 60-month term and 4% interest rate results in a $ monthly payment where the very first payment is comprised of $100 in interest and $ in principal. In contrast, the very last payment is just $2 in interest and $ in principal. The total cost to borrow the money for the car is $3,150 in interest over the life of the 5-year loan. It helps to make your own amortization table based on the interest rate you can realistically shop around for based on your location, credit rating, and the type of vehicle you have in mind so you can better understand where your car payment is going.