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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-RahmanUpdated September 10, 2023
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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.You must pay down the principal and cover any finance charges owed on your car loan. Auto loans can come with fixed interest rates that never change or variable interest rates that can fluctuate over the life of your 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 auto lending generally requires you to repay your principal and any finance charges over a set term.You may have the option to reduce your 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 $40,000 in financing under a 60-month car loan begins with an outstanding principal balance of $40,000. 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 minimum 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 interest you pay over the life of your loan.For example, the minimum monthly payment on a $40,000 car loan with a 60-month term and 7% simple interest rate is about $792. Paying that amount for 60 consecutive months would result in you paying $40,000 in loan principal and about $7,523 in interest by the 60th payment. Paying an extra $10 per month, however, would result in you paying $40,000 in principal and about $7,407 in interest over the life of the loan.

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 that might apply. The principal is the amount of money you borrow to finance the purchase of a new or used car.If you have a $40,000 car loan with a 60-month term and 0% annual percentage rate (APR), you would be expected to repay $40,000 by the end of the 60-month term. In this example, you could satisfy the debt by making 60 monthly payments of $666.67.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 an auto financing agreement. Car loans typically have a simple interest rate rather than a precomputed rate.Recommended: Precomputed Interest Car Loans

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 a recurring $5 extra payment each month toward principal without penalty.Consider the following points:
  • You may have the option to make extra payments on a car loan with no prepayment penalty
  • Some lenders may allow you to designate your extra payment as principal only
  • Making extra payments toward principal can reduce your total interest costs over the life of the loan
  • Your final car payment may go down if you pay extra each month
Paying the principal on a car loan with ordinary and extra payments can minimize your interest charges and allow you to get out of debt faster. 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 upfront when the loan is made, whereas interest on a simple-interest loan typically accrues daily on your outstanding principal balance. Making extra payments on a simple-interest loan can therefore generate more savings than making extra payments on a precomputed loan.You may be entitled to a refund if you pay off your precomputed interest auto loan early. The refund, however, is typically lower than what you might have saved if the loan had charged daily simple interest on your outstanding principal balance.Making extra payments might make the most sense if your lender charges daily simple interest. In general, less interest will accrue over the life of your loan if you pay extra on a simple-interest loan.Recommended: Guide to Car Loan Interest Rates

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 the minimum required payment amount 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 required payment amount each month. 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 loan.Borrowers may also have the option of paying 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 simple-interest car loan.You can also pay off the principal loan amount with auto refinancing. Consider the following points:Refinancing can help borrowers get a lower interest rate, but lowering your monthly payment by extending your loan term could increase your total interest costs. Auto refinancing may also cause your credit score to dip if the refinance company checks your credit report with a hard inquiry.

Paying Down Principal vs Paying Down Interest

The below table compares paying down principal vs. paying down interest:
Paying Down PrincipalPaying Down Interest
Repays the money you borrowedCovers any interest charges owed
Can minimize your total interest costs if you make extra paymentsBorrowers cannot pay extra interest
Typically required each month until the debt is paid offDoes not apply if the loan has 0% APR

Paying Down the Principal vs Refinancing Your Car Loan

The below table compares paying down car loan principal vs. refinancing your car loan:
Paying Down PrincipalRefinancing Your Car Loan
Keeps your car loan in good standingReplaces your existing loan with new terms and conditions
Upholds your financial obligations on the debtCan potentially increase your total interest costs if you refinance for a longer term
Gives you the car title and full ownership of the car when final payment is madeLeaves you indebted and doesn’t give you the car title or full ownership of the car
Making extra payments can minimize your interest costsMay give you a lower APR and monthly payment

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 total interest costs over the life of the loan.As mentioned earlier, the minimum monthly payment on a $40,000 car loan with a 60-month term and 7% simple interest rate is about $792. Paying that amount for 60 consecutive months would result in you paying $40,000 in loan principal and about $7,523 in interest by the 60th payment. Paying an extra $10 per month, however, would result in you paying about $7,407 in interest over the life of the loan.In some cases it might be better for you to make minimum 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.Here are some points to consider:Auto leasing is another financing option you may consider if you need access to a new car. When considering the option of leasing vs. buying a car, you could lease 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.

The Takeaway

Paying the principal on a car loan is required whenever you borrow auto financing. You can make minimum payments each month or extra payments to pay off your debt early.If you need a lower monthly payment on a car loan, Lantern by SoFi can help. Just provide some details on your current car loan and search for auto refinance offers. Lantern can help you find prequalified rate offers within minutes.

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?
Photo credit: iStock/SeventyFour
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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 served 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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