Bankrate.com
News & Advice Compare Rates Calculators
Rate Alerts  |  Glossary  |  Help
Mortgage Home
Equity
Auto CDs &
Investments
Retirement Checking &
Savings
Credit
Cards
Debt
Management
College
Finance
Taxes Personal
Finance

Paying ahead vs. paying down principal on loan

Dear Steve,
I started with a 72-month, $23,468 auto loan in March 2003. I've paid $400 every month to the present date, although the required payment is only $325 a month. I just found out that the extra money is not going to principal, but it adds time until my next payment is due, which the bank says is in August 2005. How will this help me if I want to trade vehicles in two years? By then the bank will say that I have 10 to 11 months of no payment, due to the fact that I'm so far prepaid. Can this benefit me when I want to trade in and how does that play into the financing of another vehicle at that point? Advice needed. Thank you.
-- Nate

- advertisement -

Dear Nate,
A 72-month car loan is a long one. You seem to have thought things out to a point by making sure you could afford lower payments over a longer period of time. It may be, however, that your lender thought about it longer than you did and locked in a long stream of interest payments to offset your thinking.

From what you have said, you have not reduced the principal amount owed on the loan even though you are paying more than the agreed-upon payment. The upshot of your efforts is that you could skip a year's worth of payments and your lender would not care, because he is still making the money he expected to on this loan. What we have here is a failure to communicate!

When you pay more than is owed on a loan, it is always best to communicate to the lender that you want the additional payment amount to be applied toward the principal in order to save money on the interest. For those of you who are particularly fastidious, I suggest you send in two checks, one for the regular payment and the other for the extra, clearly marked that it is to be applied to principal. This can clarify your wishes beyond a doubt. Please note, however, that your loan may have a prepayment clause that prevents you from being able to reduce the interest paid. You will have to examine your loan documents to determine if that is the case.

If there is no prepayment clause, ask the lender to recalculate your payments thus far to apply the additional $75 per month to the principal and put you back on the same payment schedule. The lender may not choose to do this, as it will cost money, but you can certainly redirect in writing that future payments be handled that way (again assuming no prepayment clause in your original contract).

Nevertheless, when the time comes to trade your vehicle in and finance another one, your timely overpayments should certainly help you. You will have paid nearly a year longer on the vehicle and the bottom line on your loan will be less than anticipated.

As you look for your new car, be sure to read all of the fine print about prepayment options. Also, consider a shorter loan period. The $75 leeway you have afforded yourself was smart thinking, but it exposed you to carrying an upside-down debt for a very long time. By reducing, but not eliminating, the $75 margin of cushion and shortening the term of the loan, perhaps to 48 months, you keep from being upside down in your loan for a shorter period of time. This means you won't owe more on your vehicle than it is worth, which often happens with longer auto loans.

Keep up the good work and good luck!

The Debt Adviser, Steve Bucci, is the president of Consumer Credit Counseling Service of Southern New England. Visit CCCS for additional debt advice or click here to ask a debt question.

 
-- Posted: May 20, 2005
     

 

 
 

 

Looking for more stories like this? We'll send them directly to you!
Bankrate.com's corrections policy
Print   E-mail

Compare Rates
NATIONAL OVERNIGHT AVERAGES
$30K HELOC 4.38%
Personal loan 13.93%
$30K Home equity loan 4.98%
Rates may include points



RELATED CALCULATORS
  Loan calculator (includes amortization schedule)  
  See your FICO score range -- free  
  What will it take to pay off your credit card?  
VIEW ALL 

BASICS SERIES
Debt Management Basics
Take these steps
to get control
of your debt.
Do I have too much debt?
Refi or home equity loan?
Consolidate card debt
15 signs of debt trouble
What is bankruptcy?

MORE ON BANKRATE
Loan rates in your area  
Graph rate trends  
Credit scoring  
Consolidate your debt


- advertisement -

 
- advertisement -
About Bankrate | Privacy Policy/Your California Privacy Rights | Online Media Kit | Partnerships | Investor Relations | Press Room | Contact Us | Sitemap
NYSE: RATE | RSS Feeds |

* Mortgage rate may include points. See rate tables for details. Click here.
* To see the definition of overnight averages click here.

Bankrate.com ®, Copyright © 2014 Bankrate, Inc., All Rights Reserved, Terms of Use.