How paying the principal affects your car loan

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Paying down the principal on your car loan can be a good way to quickly build equity in your car. Often you need to specify to the lender that the payment is intended to only go to the principal, either online or over the phone. Each lender has its own process, though, and not all accept principal-only payments.
What is a principal-only car payment?
A principal-only car payment is a payment that goes solely toward the principal balance of your car loan and is separate from your normal monthly payment. The principal is the amount that you initially borrowed, without any interest added to it. The goal of this extra payment is to accelerate repayment of the debt.
Every payment that goes solely toward your principal builds equity in your car. As you build equity in your car, you get closer to owning it outright. It also reduces the risk of owing more than your car is worth — also called being upside-down on the loan.
How to pay down the principal on a car loan
Making a principal-only payment on your car is a good way to pay down your balance faster. While it’s not the same across all lenders, you will likely need to directly notify the lender that the payment is for the principal balance only and not an early payment of the next installment.
Check with your lender to see if it allows this type of payment and how to go about making one. If your lender doesn’t offer the option to make a principal-only payment, you may still be able to pay down your loan faster.
How to pay down your car loan faster
If you can’t make principal-only payments, you may still be able to pay off your car loan ahead of schedule. Just make sure that your lender doesn’t charge prepayment penalties before making additional payments.
- Schedule biweekly payments: You may not have the money to make a whole payment twice a month but making a half payment every other week can cut down on the overall interest paid depending on the way it’s calculated. This only works out if it is a simple interest auto loan, as precomputed interest will be applied the same regardless of when payments are made.
- Pay a little more than your minimum payment each month: Check with your lender to see if it allows this type of payment and how to go about making one. Every little bit helps when it comes to paying down the loan faster.
- Make extra lump-sum payments: If you get a bonus or tax refund, you can put it towards your car loan if it wouldn’t be better put elsewhere.
How paying down the principal on a car loan affects your credit
Paying down a car loan may seem like a good idea at first. But paying down your loan early, especially in the short term, can affect your credit.
In the short term, your score may drop by a few points, but over the long term, it could improve if you have a high debt-to-income ratio. Other factors, like your credit mix and payment history, can also affect your score.
To help determine whether paying off your car loan early is right for you, consider the following:
- Your credit mix: Paying your auto loan off early shows lenders you can manage your debt well. But your credit mix — the variety of credit accounts you have, such as a car loan, credit cards and more — may take a hit if your car loan is your only installment loan.
- Your payment history: Paying off a car loan early reduces the number of regular payments, but it doesn’t have as much of an impact as revolving debt.
- Your debt-to-income ratio: Your debt-to-income ratio is another important factor that considers how much debt you have compared to your income. Paying down a car loan may improve your DTI ratio and help to improve your credit score over time.
How to lower your monthly car payment
If your goal is to lower your monthly car payment, a principal-only payment won’t help, since it doesn’t reduce your minimum payment.
However, there are a few ways to lower your monthly car payment.
Refinance
If your credit has improved or you find a better interest rate, refinancing your car loan can save you money and potentially help you pay it off faster. When you refinance your auto loan, you take out a new loan with a different lender to pay your current loan off. This means it’s important to shop around and find the best deal possible to lower the overall cost of your loan and monthly payments.
Modify your loan
You can also talk to your current lender about modifying your current car loan. Your lender may be willing to change the terms of your loan in order to make monthly payments more affordable. One way it can do this is by extending your loan term. But doing so will mean paying more interest in the long run.
Sell or trade your car
Another way to lower your payment is to get into a less expensive vehicle. Trading in your current vehicle or selling it privately can get you the funds for a down payment. From there you can find a car that better fits your budget and shop around for the best auto loan available.
The bottom line
Paying down the principal on your car loan can be a good way to build equity. If your lender accepts additional principal payments, you can make one anytime you want.
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