If You Pay Extra on Your Car Loan, Does It Go to Principal?

Learning how car loans work requires understanding what the loan principal describes. A loan principal is the primary loan amount not otherwise accounted for as fees or interest. For example, if you purchased a car for an agreed-upon price of $35,000, not including documentation fees and sales tax, $35,000 would represent the loan principal. Any interest accrued during the loan term remains separate. 

Most auto lenders stipulate that you must pay down the interest associated with your car loan before applying any payments to the principal. These requirements apply whether your credit score is stellar or less-than-perfect. However, once you’ve fulfilled the interest payments for your loan, any subsequent payments go directly toward reducing the loan’s principal. 

If you want to pay toward the principal part of your car loan, you have to specify your intentions. Contact your lender and ask about the process for making principal-only payments. Some lenders may require you to submit your request in writing or check a particular box when you make a payment. If you follow through with this process, verify the funds have been applied by reviewing your next statement. 

Paying down principal vs. paying down interest 

Reducing your loan principal can lower your overall loan amount, limiting the amount of interest you pay over the life of the loan. However, it’s important to note the difference between auto loans with simple and precomputed interest. Lenders calculate interest upfront on a pre-computed interest loan, so extra payments have less power. In contrast, simple interest loans provide the most savings when you make additional payments. 

Paying down the principal vs. refinancing

Integral in the process of obtaining your car loan was determining how long you can get a car loan for, or what’s known as the loan term. Depending on how much you overpay, applying extra payments to your loan principal balance can shorten the loan term and help you avoid being upside-down financially on the car (owing more than it’s worth). Alternatively, refinancing the loan will lengthen the loan term but lower your monthly payments. 

Is it better to pay the principal or interest? 

Paying the loan principal is better than tackling the total interest because it allows you to reduce your interest payments and potentially pay off the loan faster. You can then use the additional money you save on interest payments for other expenses or high-interest debt. However, you should ensure your lender doesn’t charge prepayment penalties for paying off your car loan early. The money you could save would likely cover those penalty fees. 

Principal-only payments help you resolve your auto debt faster. Here are additional benefits of making payments only on your loan principal: 

• Save money that would otherwise go to interest payments
• Contribute extra funds when you’re financially able to 
• Build equity in the vehicle
• Reduce the overall cost of the loan 

The relationship between your auto loan and credit score gets complicated once you pay the loan off. When the loan is active, it helps boost your credit if you make on-time payments and adds to your new credit and credit mix. However, a closed auto loan account can reduce your debt-to-income ratio and credit mix. Yet any negative impacts to your credit from a satisfied auto loan soon give way to the positives. 

If you’ve decided to pay extra on your car loan principal, the steps below can help you put that plan into action: 

1. Review your lender’s policies to see how they handle extra or principal-only payments.
2. Schedule bi-weekly payments of half your overall monthly payment.
3. Make a one-time lump-sum payment or pay extra when you’ve got additional funds. 
4. Pay more than your monthly minimum by doubling payments or rounding up to the nearest $20, $50, or $100.

Your payments will have the most power if you apply them to the loan principal. However, simply making extra payments (as long as you specify they’re to be applied immediately) can still help you pay off your loan faster. 

If you’re curious about how to pay off a car loan faster, regardless of principal-only payments, the work begins before you even send in the first payment. When you’re negotiating your car purchase, use your down payment to cover the taxes instead of financing them. You can also put extra money down to reduce your overall car loan amount. In addition, opting for a cheaper car can also help you pay down the amount faster. 

Additional methods for paying off your car loan in less time than the maturity date include: 

Refinance your auto loan for a potentially lower interest rate, lower monthly payments, but longer loan terms

• Use your tax refund to knock out a sizeable portion of the auto loan
• Review your add-ons and inquire about canceling coverage to get reimbursed  

Taking on a side job can also help you earn additional money to put toward your car loan. If you rack up enough funds, you may even be able to pay off your car loan in full. Again, check to see if your lender charges prepayment penalties before you send any significant funds their way. 

Paying extra on a car loan principal depends on your financial situation, both at the present and in the near future. Pay extra on your loan principal if you have extra cash and want to get out of debt sooner. If your loan is subject to a high interest rate, paying off the principal sooner can help your overall interest payments. 

However, you shouldn’t pay extra on your car loan if you can’t afford it. If your emergency fund can’t cover three or more months of your expenses, it’s best to contribute to that instead of paying down the loan principal. In addition, paying down other high-interest debt, such as credit card balances, can better serve your credit.