Getting out of debt is an important financial milestone. And making additional payments can significantly reduce your balance while saving money on interest.
But if you intend to make additional payments on your debt, it’s important to understand how these payments work. Any the extra payment will help you get out of debt faster, but paying only the principal will allow you to embark on the journey to a new debt-free life.
What is the main payment?
Usually, when you make a payment on a loan, the lender applies a portion of your payment to interest and fees before it reduces the principal—the money you actually borrowed from the lender.
Let’s say you have a loan of $10,000 at 6% per annum with a monthly payment of $111. At the beginning of the loan term, your payments will be divided into approximately $61 principal and $50 interest.
If you make an additional payment within a month, in many cases the lender will still use the same formula. So the lender adds up the interest accrued during the month and uses part of your payment to pay the accrued interest before applying it to your principal.
On the other hand, payment only on account of the principal debt is fully aimed at reducing the principal debt. Since the amount of interest charged is based on your principal amount, your interest accrues less as your principal amount decreases.
Paying only the principal can speed up your debt repayment period and save money on interest. This is especially true with credit card interest, as many credit cards charge interest on a daily basis. If you can make an additional monthly credit card payment of only the principal amount, your interest will accrue much more slowly, which will help you get rid of credit card debt much faster.
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Read more: How to pay off credit card debt quickly
How to make a payment only on the principal debt
Unfortunately, not every lender allows additional loan payments without charging a fee. And while some lenders may allow you to make additional payments without penalty, you may still see a portion of the payment go towards interest unless you specify that you only want to pay the principal amount.
If you want to make an additional payment of only the principal amount, start by checking your lender’s repayment policy. Each lender has their own process for paying only the principal amount of the debt (if they allow it). You may have to make an additional payment at the same time as your regular payment. In some cases, you may need to obtain an additional payment receipt and check the “principal only” box.
Automate your payments
When possible, the best way to make payments is to automate them. Some lenders allow you to make an additional automatic payment every month, indicating that each additional payment goes towards the principal.
If you can set this up online or over the phone, it can help you manage your debt without having to manually and regularly make an additional payment every month.
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Pay attention to early repayment penalties
Be aware that some lenders do not allow payments on principal only. You can make additional payments each month, but they won’t apply to the principal only. However, in these cases there is still an advantage to making an extra payment because you will pay off the debt faster anyway.
On the other hand, there are lenders who not only do not allow you to make payments only on the principal debt, but also charge penalties for early repayment. Thus, if you repay the loan early, you may be charged an additional fee. These lenders are trying to recoup some of the lost interest from your expedited payments by charging you a fee.
Before proceeding with additional payments, calculate. See if there is a prepayment penalty, and if there is, see if your interest savings will be big enough to offset this fee.
Consider refinancing with a new lender
If you still have a significant balance to pay off ($5,000 or more) and your current lender will charge you a prepayment penalty every time you want to make an additional payment, do a little research to see if you can whether you find a lender offering better terms.
If you find a new lender with a competitive interest rate and flexible repayment terms, it may make sense to pay your current lender a one-time fee to refinance/consolidate your debt to the new lender and free yourself from repeated prepayment fees. .
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You can explore new consolidation and refinancing options by entering your basic loan details below.
How does principal-only payments reduce your debt faster?
To give you an example of how much you can save by paying only the principal, lLet’s take a look at a $15,000 car loan that is offered for four years at 5% interest.
The Money Under 30 Extra Payment Loan Calculator shows that you can expect to pay approximately $1,581.12 in interest if you continue to make regular payments on the loan until it is repaid.
But if you make an additional payment of $150 per month, you’ll save $315.60 in interest.
Although this does not seem like a huge difference, the larger the loan balance and the longer the loan term, the greater the savings. The interest rate can also affect the impact of additional payments only on account of the principal debt. The more you withdraw from the principal each month, the more you save on interest.
It’s also worth considering one-time payments of only the principal amount, even if you can’t make regular additional payments. If you receive a bonus or tax refund, using that money to pay only the principal can reduce your debt and ultimately reduce your interest payments.
How about bi-weekly payments?
If you’re not sure you can make an extra payment each month, you can reduce the interest you pay and the time you spend on debt by making biweekly payments instead. Split your monthly payment in half and set up your account to pay bi-weekly. You will make 26 payments per year. That adds up to one additional monthly payment per year—without having to strain your budget.
Realize, however, that when you make bi-weekly payments, you often end up paying principal and interest on each payment. Your lender usually doesn’t consider one of your payments to be just the principal. However, you can still save over the normal term by paying off your debts earlier and paying less interest using bi-weekly installments.
If you have the money to make additional biweekly payments, the effect can be even greater. You can save more money and pay off debt faster if you combine extra payments with biweekly payments. Review your budget to see what you can manage.
Summary
Making only principal payments can be one of the best strategies for paying off your debt quickly, as long as your lender doesn’t charge you hefty prepayment penalties.
If your lender’s prepayment terms are inflexible or punitive, you should at least look into refinancing with a more flexible lender. Flexible loan terms and aggressive repayment are a winning combination in the fight against debt.