When You Pay Extra on a Car Loan, Does it Go to Principal?

Paying off debt faster is a key strategy for many people looking to improve their finances. And for those with car loans, making extra payments can be an effective way to pay down the balance quicker. But there’s an important nuance with car loans that not everyone realizes – extra payments don’t always go straight to the principal.

So when you pay extra on a car loan, does it automatically go toward the principal balance? Or could it go somewhere else? Understanding where extra car payments go and how to ensure funds hit the principal can save you money on interest and help you pay off your auto loan faster.

How Car Loan Payments Typically Work

With most loans including car loans your regular monthly payments don’t all go toward the principal balance. Here’s a quick breakdown of where your payment funds are applied

• Interest – A portion of each payment goes toward accrued interest charges. This is based on your loan’s interest rate and outstanding principal amount.

• Principal – The rest of the payment goes toward the principal balance (the amount borrowed) This brings down the total amount owed.

• Fees – Any applicable fees may also come out of your payment.

So in a regular car payment, the interest and fees get paid first before anything touches the principal balance. This means the principal gets paid down slowly over the full loan repayment term.

Extra Payments Go To Interest First By Default

Now what happens when you make an extra payment in addition to your regular monthly car payment?

In most cases, extra funds don’t automatically get applied to the principal balance. Unless specified, extra payments typically go toward paying the next month’s interest first.

That’s not ideal if your goal is to pay down the principal faster. While it will save a bit on total interest costs, it doesn’t accelerate reducing the loan balance itself.

For example, let’s say your monthly car payment is $300 and you pay an extra $100 one month. If the extra $100 simply goes to prepay the next month’s interest charges, your principal balance stays the same. No progress made on your payoff goal.

How To Ensure Extra Funds Hit the Principal

To guarantee any extra payments reach the principal balance, you need to formally request it with your lender. Here are some tips:

• Ask your lender – Contact your lender to ask about their process for applying additional funds to the principal balance.

• Follow payment instructions – Your lender may have special repayment instructions to tag extra principal payments. This may include using a coupon, writing a note on your check, or sending funds to a specific address.

• Specify with each payment – Every time you submit extra funds, include a request for it to go “toward principal only.” Don’t assume your lender will remember previous requests.

• Review statements – Verify on your monthly statements that extra payments were properly applied to the principal balance, not just interest.

Following the correct steps with each extra payment is the only surefire way to knock down your car loan principal faster.

Benefits of Paying Extra Toward the Principal

Making extra payments toward your car loan principal balance can really accelerate your payoff timeline. Here are some of the biggest benefits:

• Pay less interest – Since the principal gets paid down faster, you pay less total interest over the loan term. Given interest charges are front-loaded, extra principal payments made early in your loan term save the most on interest.

• Pay off the loan faster – The reduced principal balance shortens how long it takes to fully pay off the car loan. You could shave months or even years off the repayment timeline.

• Build equity faster – Paying down the principal quicker helps you build equity in the vehicle faster, reducing the risk of being “upside down” or owing more than it’s worth.

• Improve credit – Paying off installment debt like a car loan can give your credit scores a nice boost. Plus it frees up cash flow for other goals.

Other Ways to Pay Off Your Car Loan Faster

Making regular extra payments toward the principal is one of the most effective ways to accelerate debt payoff. But if that’s not possible, here are a few other options:

• Refinance the loan – Consider refinancing your car loan at a lower interest rate. This reduces the total interest costs over the loan term.

• Pay biweekly – Make half your monthly payment every other week. This equates to an extra full monthly payment each year.

• Pay yearly lump sums – Contribute a larger chunk of cash once a year, like from a tax refund or bonus.

• Trade it in – Trading in the car for something cheaper can lower the amount you owe. But watch out for dealer fees getting added to the new loan.

The right debt payoff strategy depends on your budget, interest rate, loan balance, time left on the term, and personal goals. Crunch the numbers to see which approach helps you optimize interest savings.

Is Paying Extra on Your Car Loan the Right Move?

Deciding whether to pay extra on your auto loan comes down to a couple key factors:

Your budget – Make sure you can truly afford extra payments without shortchanging other priorities like an emergency fund or retirement savings. Avoid accruing new debt to pay off a car faster.

Interest rate – The higher your interest rate, the greater the interest savings from accelerating your principal paydown. Weigh the savings against any prepayment penalties.

Other debts – If you have higher interest credit cards or other debt, it may be smarter to focus any extra funds on those balances before making car loan prepayments.

Credit goals – Paying off installment debt like a car loan can boost your credit. But going too aggressively may shorten your credit history mix which could negatively impact your scores short-term.

Crunch the numbers for your unique situation. Paying extra on a car loan can be a savvy financial play but make sure it aligns with your broader budget and debt payoff priorities. Maintaining a balanced approach is key.

The Bottom Line

When you send extra money toward your car loan, don’t assume it automatically hits the principal balance. For the fastest debt paydown, you need to formally request any additional funds be applied to the principal only. Follow your lender’s instructions carefully with each extra payment.

Knocking down the principal faster saves on total interest costs and shortens your payoff timeline. Just make sure paying extra fits comfortably within your budget and doesn’t jeopardize other financial goals. Done strategically, paying extra on a car loan can accelerate your path to becoming debt-free.

Generally, extra payments on a loan do not automatically go to the principal. Lenders may apply extra payments to the interest first, then to the principal, or they might have a specific process you need to follow to ensure the extra payment reduces the principal.

To ensure extra car payments go directly toward the principal, contact your lender and inquire about their process for principal-only payments. They might have specific instructions like marking a checkbox or including a note with the payment.

Paying extra on your car loan will reduce the principal balance, leading to paying off the loan sooner and saving on interest. While your monthly payment amount typically won’t change, the extra amount goes directly towards reducing the amount you owe, rather than being applied to future interest.

Yes, you can pay off a 72-month car loan early. There are typically no legal restrictions preventing you from doing so, but it’s crucial to check your loan agreement for potential prepayment penalties.