What Is a Principal-Only Payment on a Car Loan?
Discover a smart way to accelerate your car loan repayment and cut down on interest costs. Optimize your debt strategy.
A car loan facilitates the purchase of a vehicle by allowing a borrower to pay for it over an agreed-upon period rather than upfront. While a regular monthly payment is standard for these loans, some borrowers may choose to make additional payments. This article explains the concept of a principal-only payment, offering clarity on its function and the steps involved in making one.
Understanding Car Loan Payments
A typical car loan payment consists of two primary components: principal and interest. The principal is the actual amount borrowed to finance the vehicle. Interest is the cost charged by the lender, calculated as a percentage of the outstanding principal balance.
Over the loan’s life, the allocation between principal and interest within each monthly payment shifts. Initially, a larger portion applies to interest, with a smaller amount reducing the principal. As the loan matures, a greater share goes towards paying down the principal. This means early in the loan term, even a small reduction in principal can significantly impact the total interest paid.
How Principal-Only Payments Function
A principal-only payment is an additional payment specifically designated to reduce the outstanding principal balance of a car loan, separate from the regular monthly installment. This payment does not cover accrued interest or substitute for a scheduled monthly payment. The entire amount is directly applied to the original sum borrowed.
The immediate impact is a direct reduction in the amount owed. Because interest is calculated on the remaining principal balance, a lower principal leads to less interest accruing over the loan’s life. Making these payments can result in substantial overall interest savings and shorten the loan term, allowing the borrower to become debt-free sooner.
It is important to ensure the lender correctly applies these extra funds solely to the principal, rather than allocating them to future interest or applying them as a prepayment for an upcoming regular installment.
Steps to Make a Principal-Only Payment
Making a principal-only payment requires clear communication with your lender to ensure the funds are applied correctly. Most lenders offer various methods, including online portals, phone calls, or mail. When using an online platform, look for a specific option to apply an extra payment directly to the principal. If paying by phone or mail, explicitly state or write “principal only” on the check’s memo line or payment coupon.
After making the payment, verify with your lender that the funds were applied to the principal balance. Reviewing your loan statement or checking your online account after the payment posts can confirm the reduction in your principal balance.
While many lenders allow principal-only payments, some may have specific requirements, such as a minimum amount for these extra payments, which can range from $10 to $50.