What Happens If I Pay $100 Extra on My Car Loan?
Understand the financial impact of extra car loan payments, how to make them, and key considerations for saving money.
Making an extra payment on your car loan means paying more than the minimum amount due. This goes beyond your contractual obligation and can change your loan’s trajectory. While regular payments cover principal and interest, an additional payment, when applied correctly, can significantly alter the loan’s overall cost and duration.
How Extra Payments Reduce Your Loan
An additional payment, especially when directed towards the principal, directly reduces the outstanding loan balance. Most auto loans operate on a simple interest basis, meaning that interest is calculated daily on the remaining principal balance. Lowering the principal immediately decreases the amount on which future interest is calculated.
A car loan typically follows an amortization schedule, which outlines how each payment is split between interest and principal over the loan’s term. Early in the loan, a larger portion of your payment goes towards interest, while later payments allocate more to the principal. An extra payment effectively “jumps ahead” on this schedule, reducing the principal faster than originally planned. This accelerates the point at which more of your regular payments begin to chip away at the principal rather than the interest.
This accelerated reduction of the principal has a compounding effect on interest savings. Since interest is continuously calculated on a smaller outstanding balance, less interest accrues over the remaining life of the loan. For example, if your principal is $10,000 and you pay an extra $100 directly to principal, your new principal becomes $9,900. The next interest calculation will be based on this lower amount, leading to less interest charged.
The combined effect of reducing the principal and lowering the total interest paid also shortens the overall repayment period. Consistently making extra payments pays off the loan balance sooner, potentially saving hundreds or thousands in interest charges. This means you become debt-free from your car loan earlier, freeing up that portion of your budget for other financial goals.
Key Considerations Before Making Extra Payments
Before making an extra payment, it is important to review your car loan agreement thoroughly. This document contains specific terms that dictate how your payments are applied and whether any penalties exist for early repayment.
One specific term to look for is a “prepayment penalty.” While not common for most auto loans, some lenders may include clauses that charge a fee if you pay off your loan early or make extra payments. These penalties are typically designed to recoup some of the interest income the lender would have earned had the loan run its full course. If a prepayment penalty is present, it is often a percentage of the outstanding balance, usually around 2%. If your loan has such a penalty, you should calculate whether the interest savings from an extra payment outweigh the penalty fee.
Another important aspect to confirm is how your lender applies extra payments. Some lenders may automatically apply any overpayment to future scheduled payments, which means the funds might cover upcoming interest and principal, but not necessarily reduce your current principal balance immediately. To ensure your extra payment directly reduces the principal, you often need to specifically designate it as a “principal-only” payment. You can typically find information on how extra payments are handled by reviewing your loan contract, checking your lender’s online portal, or contacting their customer service department.
Executing Your Extra Payment
After reviewing your loan agreement and understanding how your lender handles extra payments, you can submit additional funds. The most common methods for making an extra payment include using your lender’s online portal, mailing a check, or calling customer service. Each method requires careful attention to ensure the payment is applied correctly to the principal.
When using an online portal, navigate to the payment section. Look for options that allow you to make an extra payment or specify how additional funds should be applied. Some online systems may have a specific checkbox or field to designate a payment as “principal-only.” If this option is available, ensure you select it before submitting the payment.
If you choose to mail a check, clearly indicate your intention for the extra funds. Write “for principal only” on the check’s memo line and include a note with your account number stating the additional amount should be applied solely to the principal.
Alternatively, you can call your lender’s customer service department. When speaking with a representative, explicitly state that you wish to make an extra payment and that you want the entire additional amount applied directly to the principal of your loan. Confirm with the representative that they understand your request and will process the payment accordingly. After making the payment, regardless of the method, it is advisable to check your online account statements or the next monthly statement to verify that the extra funds were received and correctly applied to your principal balance.