A loanâs principal balance is generally the amount you initially borrowed. Making extra principal-only payments can decrease how much interest accrues on your loan and how long it takes you to pay off the debt.
A principal payment is a loan payment that goes toward a loans principal balance. Generally, the principal is the amount you borrowed and thats accruing interest. But sometimes, unpaid interest can be capitalized, or added to the principal balance.
With amortizing loans, which most installment loans are, a portion of each payment pays off the interest and fees that accrued since your last payment and the remainder pays down the principal balance. Over time, less interest accrues and a larger portion of each payment goes toward the principal balance.
When you take out a loan you agree to repay the amount you borrowed (the principal) plus interest over a set period of time. The interest is calculated based on the outstanding principal balance – the amount you still owe. This means that the more principal you pay off the less interest you’ll owe overall. So what happens if you focus on paying off the principal before you’ve paid all the interest?
How Principal and Interest Work on Loans
With most loans, your monthly payments go first towards interest accrued since your last payment, and the remainder goes to pay down the principal. Over time, as the principal is reduced, less interest accrues each month and more of your payment goes to principal.
For example, let’s say you take out a $100,000 loan at 5% interest over 15 years. Your monthly payment would be around $704. In the first month, about $417 of that $704 goes to interest and $287 goes to principal. After 5 years of payments, your principal balance is around $86,000. Now only $358 of your $704 payment goes to interest and $346 goes to principal.
Benefits of Paying Extra Principal
When you make an extra payment towards the principal – above your regular monthly payment – you reduce your overall interest costs and can pay off the loan faster.
Here are some key benefits of paying extra principal:
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Save money on interest: Less principal owes less interest, so paying extra principal reduces your total interest costs over the life of the loan. This saves you money.
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Pay off the loan faster: Paying down the principal faster means you’ll pay off the entire loan sooner. This can shave years off a long-term loan like a mortgage.
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Build home equity faster: When you owe less principal on your mortgage, you build equity in your home faster. This gives you financial flexibility.
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Lower vulnerability to interest rate hikes: If rates rise, your payment will go up less if you’ve already paid down more principal.
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Increase cash flow earlier: Getting the loan paid off faster frees up cash sooner for other goals once the loan is gone.
How Much Should You Pay Towards Principal?
There’s no set rule on how much extra you need to pay towards principal. It depends on your financial situation and goals. Even small extra amounts can make a difference, especially early in the loan term.
As a general guideline, if you can afford to pay an extra 10-20% towards principal monthly, you’ll see good results. On a $100,000 loan, that would mean an extra $100-$200 a month. The more you can pay, the faster you’ll pay down the loan.
Be sure to have a budget and ensure you can afford the extra payments without sacrificing other financial priorities. Don’t stretch yourself too thin.
Strategies for Paying Extra Principal
Here are some tips to help you pay extra towards principal:
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Make biweekly payments instead of monthly to achieve an extra month’s worth of payments per year.
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Split your payment in two – make your regular payment as scheduled, then make an extra principal-only payment later in the month.
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Pay a lump sum with a tax refund, bonus, or other windfall. Prioritize extra principal over other spending.
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Recast or refinance – reducing the principal balance can allow you to recast or refinance for better terms.
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Use a HELOC to pay down principal – a home equity line of credit with a lower rate can save on interest.
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Shift gears – pay minimums when money is tight, then ramp up extra principal payments when possible.
Key Considerations
Before putting extra money towards principal, be aware of a few key factors:
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Prepayment penalties – some loans charge fees if you pay off early in the first few years. Check if they apply.
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Interest savings – loans with precomputed interest won’t save on interest from extra principal payments.
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Access to funds – extra payments reduce how much you owe but also your immediate access to those funds if needed.
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Tax deductions – paying off a deductible loan like a mortgage faster means reducing beneficial tax deductions sooner.
As long as you’ve done the math and know the implications, paying extra towards principal can unlock significant interest savings and accelerated payoff timelines. Evaluate your own situation carefully and crunch the numbers to see if focusing on principal early on makes sense for your financial goals.
Pros and Cons of Principal-Only Payments
Consider the pros and cons before making principal-only payments on your loans.
- Pay less interest overall: Paying down the principal generally results in less interest accruing over the loans lifetime, which can save you money overall.
- Pay off the loan sooner: You may be able to pay off the loan early if you pay down the principal enough.
- Choose the payment amounts: You can set aside money and make a principal-only payment once you feel comfortableâyou dont need to commit to paying an additional amount each month.
- Wont lower your monthly payments: Your monthly payment will generally stay the same, even if you make a large principal-only payment.
- Decreases your available cash: You wont have the money on hand to pay down other debts or take advantage of opportunities that arise.
- Might not offer any benefits: Some loans have precomputed interest based on the loan amount, so paying down the principal balance wont save you money. Loans also might have prepayment penalties, although these are generally only charged when you pay off the loan in full during the first couple of years.
What Is a Principal-Only Payment?
A principal-only payment is generally an extra payment that you make on your loan. Doing so can help you pay off the loan early and save you money overall.
For example, say you have a $400,000 mortgage with a 6% interest rate and $2,398.20 monthly payments. You decide to make an extra $200 monthly principal-only payment and stick with the plan for three years.
Although your monthly payment doesnt change, the portion of each payment that goes toward interest will decrease faster.
| First Payment: Principal / Interest | 12th Payment: Principal / Interest | 24th Payment: Principal / Interest | 36th Payment: Principal / Interest | |
|---|---|---|---|---|
| No Extra Payments | $398 / $2,000 | $421 / $1,978 | $447 / $1,952 | $474 / $1,924 |
| Extra $200 Monthly Principal-Only Payments | $598 / $2,000 | $632 / $1,967 | $671 / $1,927 | $712 / $1,886 |
- Total interest savings over three years: $1,220. Although your required monthly payment doesnt change, less interest accrues because youre paying down the principal faster.
- Difference in remaining mortgage balance after three years: $10,820. The combination of making extra payments and paying less interest can quickly add up.
You might be able to make principal-only payments on installment loans, such as a mortgage, auto loan, student loan or personal loan. However, youll need to check with your loan servicer to confirm its an option and find out how the lender will apply your payment to the account.
If you simply send more than you owe, the lender might put the money into an escrow account and the unapplied funds wont pay down your principal or save you money.
How Do Principal Payments Work On A Home Mortgage?
FAQ
Can you pay off just principal before interest?
It may seem like a dream, but it can be possible if you can make — and your lender accepts — principal-only payments. Principal-only payments are a way to potentially shorten the length of a loan and save on interest.May 14, 2025
What happens if I pay off my principal early?
Is it better to pay off interest or principal first?
Because interest is calculated against the principal balance, paying down the principal in less time on your mortgage reduces the interest you’ll pay. Even small additional principal payments can help. Here are a few example scenarios with some estimated results for additional payments.
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