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Paying the Principal on a Car Loan: What You Need to Know

Paying the Principal on a Car Loan: What You Need to Know
Sulaiman Abdur-Rahman

Sulaiman Abdur-Rahman

Updated May 16, 2022
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Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.
Buying a new or used car with an auto loan always requires you to make principal payments over a set term. The principal is the amount of money you borrow to finance the purchase of your vehicle. Paying the principal on a car loan can be done on a monthly basis over the life of the loan.Borrowers must repay the principal and any finance charges on the car loan. Auto loan agreements generally include a fixed payment schedule requiring the borrower to make fixed monthly payments over the life of the loan.Car loans can have short terms under 48 months or longer terms approaching or exceeding 144 months. Financing the purchase of a car with an auto loan may require you to repay principal in full and simple interest charges. Borrowers might have the option to reduce their overall interest costs by making extra car loan payments toward principal. Below we highlight the difference between paying down principal vs. paying down interest.

What Is Principal Balance on a Car Loan?

The principal balance on a car loan is the total amount of money you owe in principal and doesn’t include finance charges or late fees. For example, getting $25,000 in financing under a 60-month car loan begins with an outstanding principal balance of $25,000. In a typical car loan, the principal balance would shrink with each monthly payment you make on the loan.Car loans generally include a car loan amortization payment schedule. This means borrowers are generally required to make fixed monthly payments over the life of the car loan. Monthly repayments may go toward principal, interest, and fees. Making extra payments toward principal can reduce the amount of simple interest you pay over the life of the loan.For example, a $25,000 car loan with a 60-month term and 6% simple interest rate would include a $483.32 monthly payment obligation. Paying that amount for 60 consecutive months would result in you paying $25,000 in principal and about $3,999 in interest by the 60th payment. Paying an extra $5 per month, however, would result in you paying $25,000 in principal and $3,950 in interest over 60 months.

Can I Pay the Principal on My Car Loan?

One of the obligations of a car loan is that you repay the principal in full plus any interest charges and fees. The principal is the amount of money you borrow to finance the purchase of a new or used car.If you have a $25,000 car loan with a 60-month term and 0% annual percentage rate of interest, you would be expected to repay $25,000 by the end of the 60-month term. In this example, you could satisfy the debt by making 60 monthly payments of $416.67.The way how a car loan works is you borrow money from a lender, purchase a vehicle from a seller, and then repay the loan over a set period under the terms and conditions of a loan agreement. Car loans usually have a simple interest rate rather than a precomputed rate.Borrowers may have the option to make extra payments with no penalty. Some lenders may allow these borrowers to designate an extra payment as principal only. Making extra payments toward principal can reduce the interest charges over the life of your car loan. Making extra payments might make the most sense if your car loan features simple car loan interest charges. A simple interest car loan includes a fixed monthly payment in which the amount going toward interest decreases over the life of the loan.

How to Pay Principal on Car Loan

Borrowers may have different options for paying the principal on a car loan. One option is for the borrower to simply repay the loan in accordance with the loan payment schedule. Making regular payments each month will allow you to fully repay the principal loan amount by the final scheduled payment date, aka the loan maturity date.Another option borrowers may have is to make extra payments above and beyond the regular monthly payment. As mentioned earlier, some lenders may allow borrowers to designate an extra payment as principal only. Making extra payments toward principal can reduce simple interest charges over the life of your car loan.Borrowers may also have the option to pay off the car loan early without incurring any prepayment penalties. For example, a borrower with a 60-month car loan could pay off the remaining loan balance well before the 60th payment date. Paying the loan off early may minimize the amount of interest you pay on a car loan featuring simple interest charges.You can also pay off the principal loan amount by getting an auto refinance loan. Refinancing pays off the original loan agreement and replaces it with new loan terms. Borrowers can refinance auto loans almost immediately.The best time to refinance the automobile may be whenever you can secure a lower interest rate or whenever you need a lower monthly payment. The cons and pros of automobile refinancing are something you may consider when evaluating whether to seek an auto refinance loan.The cost to refinance automobile loan obligations may include a number of fees that can be a dealbreaker for some consumers. Refinancing can help borrowers get a lower interest rate, but refinancing may also cause a borrower’s credit score to dip from a hard pull credit check.

Paying Down Principal vs Paying Down Interest

The below table compares paying down principal vs. paying down interest:

Paying Down the Principal vs Refinancing Your Car Loan

The below table compares paying down car loan principal vs. refinancing your car loan:

Is It Better to Pay the Principal or Interest?

Borrowers who can afford to pay extra principal on a car loan may find that better than paying maximum interest charges. If you have a car loan with simple interest, paying extra principal may minimize your interest costs over the life of the loan.As mentioned earlier, a $25,000 car loan with a 60-month term and 6% simple interest rate would include a $483.32 monthly payment obligation. Paying that amount for 60 consecutive months would result in you paying $25,000 in principal and about $3,999 in interest. Paying an extra $5 per month, however, would result in you paying $25,000 in principal and $3,950 in interest over 60 months.In some cases it might be better for you to make regular payments on the car loan and nothing extra. Some lenders, for example, may charge a prepayment penalty if you pay off the car loan early. What’s best for you may depend on the terms and conditions of your loan agreement and your personal financial circumstances.Lenders may have car loan requirements requiring borrowers to provide proof of identity and proof of income when applying for financing. In terms of how to save money on a car, making larger down payments can reduce your monthly payment obligations on a car loan.A private party auto loan can provide you with financing to buy a used vehicle from a private person selling a car. Banks, credit unions, or nonbank financial institutions may offer these loans.Consumers may also consider other financing options. When considering the option of leasing vs. buying a car, you could finance a vehicle through a standard three-year contract with a leasing company. A car lease typically includes a lower monthly payment than auto loan financing.

Will My Car Payment Go Down if I Pay Extra?

Your final car payment may go down if you pay extra toward principal. For example, a $25,000 car loan with a 60-month term and 6% simple interest rate would include a $483.32 monthly payment obligation. The 60th and final payment on that loan would be about $139 if you’re allowed to make $5 extra payments per month toward principal without penalty.Paying the principal on a car loan with both regular and extra payments can minimize your interest charges in many cases. Some car loans, however, may include precomputed interest charges. Making extra payments on a car loan with precomputed interest is generally not as beneficial as making extra payments on a car loan with simple interest.The interest on a precomputed loan is calculated up front when the loan is made, not monthly like simple-interest loans. Making extra payments on a simple-interest loan can therefore generate more savings than making extra payments on a precomputed loan.Lantern by SoFi can help you refinance auto loan obligations. Refinancing can replace your existing loan agreement with new terms that may lower your monthly payment. Check your rate today and see if you prequalify.
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Frequently Asked Questions

Can you pay down the principal on a car loan?
Is it better to pay the principal or interest?
Will my car payment go down if I pay extra?

About the Author

Sulaiman Abdur-Rahman

Sulaiman Abdur-Rahman

Sulaiman Abdur-Rahman writes about personal loans, auto loans, student loans, and other personal finance topics for Lantern. He’s the recipient of more than 10 journalism awards and currently serves as a New Jersey Society of Professional Journalists board member. An alumnus of the Philadelphia-based Temple University, Abdur-Rahman is a strong advocate of the First Amendment and freedom of speech.
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