The quicker you’re able to pay down the principal of your loan – or the amount of money you’re borrowing – the less interest you’ll have to pay.
The amount of money you’re borrowing is known as your principal. The interest is the cost you pay for borrowing money. Interest and fees are generally paid before your payments go towards your loan’s principal.
When paying down an auto loan, your monthly payment generally will first be applied to any fees due – for example, late fees. Next, the remaining money from your payment will be applied to any interest due. This includes interest accrued from past payments. The rest will then be applied to the principal balance of your loan. In the end, you can pay off your loan faster if you can pay down your principal more quickly.
If you want to know more about how your payments are applied to your loan balance or read your loan documents, contact your lender or loan servicer. You can also review your monthly statement to confirm how your payment was applied.
You may be able to request that your lender or servicer apply more of your payment to your loan’s principal. Check your loan documents first.
Deciding whether to pay off the principal or interest first on a loan is a common dilemma for many borrowers. The choice you make can significantly impact the total interest you pay and the length of your loan. In this comprehensive guide, we’ll delve into the intricacies of loan principal vs. interest, when to prioritize one over the other, and tips to pay off your loans faster.
Understanding Loan Principal and Interest
First, let’s go over what “principal” and “interest” mean in the context of a loan:
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Principal – This refers to the amount of money you originally borrowed, excluding any interest or fees. It’s the core amount you are obligated to repay to your lender.
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Interest – This is the cost of borrowing money, usually expressed as an annual percentage rate (APR). Interest accrues based on the outstanding principal balance.
When you make loan payments, the interest is paid first before anything goes toward reducing the principal. This means that focusing on paying down the principal can save you a lot of money in interest charges over the life of the loan.
The Advantages of Paying Principal First
Paying down the principal aggressively has some major benefits
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You’ll pay less interest overall, saving you money
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It shortens the loan repayment period.
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You build equity faster on installment loans like mortgages.
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Your monthly payments get lower faster as the principal declines.
The most important thing to remember is that paying off the principal as quickly as possible lowers the total amount of interest you pay the lender. It takes self-control and bigger monthly payments to use this method, but the long-term benefits can be well worth it.
When Paying Interest First Makes Sense
In certain situations, an interest-first strategy can work better:
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If cash flow is tight, focusing on interest allows lower monthly payments.
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Variable-rate loans with fluctuating interest can be targeted.
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Interest accrual concerns on high-rate loans are addressed.
This strategy isn’t the best way to save the most money on interest, but some borrowers may need the lower payments. The flexibility can give people time to get their finances in better shape and the chance to speed up principal payments.
Choosing the Right Payoff Strategy
Determining whether to pay principal or interest first requires assessing your financial situation and loan details, including:
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Your budget – Can you afford higher monthly payments?
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Interest rate – Higher rates favor principal paydown.
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Loan term – Shorter terms give less time for interest to accrue.
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Financial goals – Becoming debt-free quickly vs. other priorities.
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Loan type – Credit cards vs. fixed-rate installment loans.
Your personal circumstances and priorities should guide your strategy. Don’t become overwhelmed by the decision.
Tips to Pay Off Loans Faster
Here are some tips to accelerate payoff of your loans, regardless of your chosen approach:
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Make extra principal payments when possible.
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Split your direct deposit to make extra payments.
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Refinance loans at lower interest rates.
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Pay loans with the highest rates first.
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Avoid missed payments and late fees.
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Monitor your spending and free up more cash to pay down balances.
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Try the debt avalanche or debt snowball payoff methods.
The key is making a plan and sticking with it. Consistency and discipline are vital to becoming debt-free.
Paying Student Loans – Principal vs Interest
For student loan borrowers, focusing on principal first is usually the better route:
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Federal student loans have competitive fixed rates.
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Student loans have long repayment terms, accruing substantial interest.
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Education debt delays other financial goals like buying a home.
Targeting the highest-balance loans makes sense to have the greatest impact on your total debt. Keep making full payments on all other loans.
Mortgage Principal vs Interest – Which to Target?
With home loans, consider these factors when deciding on payoff methods:
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Mortgage rates remain near historic lows, favoring interest-first.
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Principal paydown builds home equity, while interest does not.
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Extra mortgage payments can go directly to principal if specified.
Run mortgage calculators to quantify the impact of extra principal payments on payoff timelines and interest savings. Refinancing is another key option to secure a lower rate.
Paying Auto Loans – Think Long Term
For auto loans, it’s wise to focus on knocking down the principal:
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Auto loan terms are shorter than mortgages or student loans.
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Higher interest luxury/sports car loans can be very expensive.
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Paying only interest prolongs becoming car payment-free.
Car loans have lower loan balances than mortgages, which makes it easier to pay off the principal early. Keep your loan term as short as possible, too.
The Last Word
Deciding whether to pay off principal or interest first requires understanding how loans work and your financial situation. While prioritizing principal minimizes total interest costs, paying interest first temporarily may make sense for some.
Implement a payoff strategy for each specific loan and remain focused on your long-term goal of becoming debt-free. Consistency and discipline are key – with the right approach for your needs, you can take control of your loans.
Know before you shop for a car or auto loan
You can get better interest rates and loan terms for your money if you ask questions before you shop. You can also save yourself valuable time and money, and reduce stress.
Paying Off Car Loan Early | Principal vs Extra Payment Explained
FAQ
Should you make extra principal payments to pay off a loan?
If you’re getting depressed thinking about how much interest you’re actually paying, there’s good news: Most lenders let you make additional principal payments to pay off a loan faster. Making extra principal payments will reduce the amount of interest you’ll pay over the life of a loan since interest is calculated on the outstanding loan balance.
Should you pay principal or interest on a loan?
When you make loan payments, you’re making interest payments first; the the remainder goes toward the principal. The next month, the interest charge is based on the outstanding principal balance. What is better to pay principal or interest? 1. Save on interest.
Should I pay down the principal on a home loan?
You will also want to make sure your monthly payments pay down the principal on the loan. Since the total amount of interest is calculated based on the principal amount, you will ultimately pay less interest as you pay down the main part of the loan. Start paying sooner than required.
Why do interest payments decrease if you pay off the principal?
As you make progress on paying off the principal, it goes down, which means that your interest payment also goes down. This is because when the principal goes down, you owe the bank less money, so they “go away for one more month.” Note that because the interest gets smaller every month the sum that goes towards the principal increases.
What is the difference between principal and interest?
Your loan’s principal is the amount you borrow. Interest is what you pay to borrow money, usually expressed as a percentage of the principal. Your loan’s principal, interest rate, repayment term and fees decide how much you ultimately have to pay back. What is principal?.
What happens if you pay more on the principal?
Again, paying more on the principal means you pay less interest, since that is a percentage calculated based on how much of the principal amount remains. WARNING: when you make extra payments, you MUST tell your loan servicer to apply this additional money to principal.
Do you pay off interest or principal first?
The amount of money you’re borrowing is known as your principal. The interest is the cost you pay for borrowing money. Interest and fees are generally paid before your payments go towards your loan’s principal.
What happens if I pay an extra $1000 a month on my mortgage principal?
A monthly payment of an extra $1,000 toward the principal of your mortgage will help you pay it off faster and with much less interest over the loan’s term.
Which debt should you pay off first?
Start chipping away at your highest-interest debt first. Every dollar counts. Once you pay off that credit card or other high-interest debt, apply the minimum payment plus a little extra to the next highest interest debt.
What happens if I pay an extra $100 a month on my car loan?