General Question

Allie's avatar

Is there a benefit to making a principle only payment on a simple interest loan?

Asked by Allie (17431points) February 16th, 2017

If you’ve got a loan charging simple interest, is there a difference in making a payment larger than your amount due vs. making a second, ‘principle only’ payment? Isn’t the extra you’re paying on the larger payment going to the principle anyway? So, isn’t that the same end as making an additional payment?
If there IS a difference, what am I missing?

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15 Answers

RocketGuy's avatar

Paying extra principle will reduce your interest costs. Sometimes the reduction is in the next payment, but there is always a reduction at the end.

tedibear's avatar

Typically, extra payments on a loan are applied in the following order:
– Fees and service charges, if any
– interest due
– principal

If you have no outstanding fees or service charges, and you are paying your loan on or before the due date, the extra money should be applied to principal. It will, in general, show up as a reduction in your next payment due. However, monetarily you end in the same spot at the end of the loan. Remember: this is only if you are paying on the due date or earlier, not if you are paying after that.

If you are paying after the due date, I suggest that you specify that the extra payment goes to principal. Because of the way some banks process their payments, I would check on this every three or four months until you are certain that the payments are applied correctly.

PS: principal, not principle.

Strauss's avatar

If you make extra payments, you should specify to the lender that any excess is to be applied to the principle. DO NOT ASSUME THIS.
Paying down the principle will result in paying less interest over the life of the loan.

Example: on a 30 year mortgage, the equivalent of an extra monthly payment every year, applied to the principle, will cut many years from the life of the loan.

tedibear's avatar

@Strauss – the application of payments on a mortgage and a simple interest loan are generally different. Unless @Allie‘s bank is really goofing up (always a possibility!) she should be okay just paying extra without separating out the two. Again, contingent upon the payment being made on or before the due date. Your information about mortgage payments is excellent!

rojo's avatar

By paying down the principal we are usually able to cut a substantial amount of money out of the interest and pay off a 15 year note in about 12 years.

I would be interested to know if there is any benefit to getting the extra principle in on, let’s say the first of the month when payment is due as opposed to the extra payment in the middle of the month. Seems like it could go either way. Are you paying out a half month ahead in the second case but in the first case are you paying out a full month ahead and generating less interest? Not sure. Hate finances.

ARE_you_kidding_me's avatar

You usually have to specify that this is a principle only. It’s a huge benefit, you reduce principle without paying interest. It’s basically the same as over paying. I do this on a 30 yr note to pay it off in 15. Either way you are usually required to tell the lender.

Allie's avatar

So, I know it’s best to always pay down the principle earlier if you can… My Q was more about the difference in the two methods…

Say my amount due is $500 and I pay $500 and the bank takes $75 for interest and the rest goes to principle. Now say I pay $700, they take out the $75 interest and then the rest goes to principle. Isn’t paying a larger payment and that extra $200 going to principle the same as paying an extra $200 in a separate ‘principle only’ payment? Or is there another benefit to making the principle payment separately (like with a second check)?

ARE_you_kidding_me's avatar

Yes it is, no real benefit to paying it seperately.

rojo's avatar

@ARE_you_kidding_me I would think that paying the extra at the time of the loan payment would save some interest over paying an extra $200 at a later date. They would have the additional $200.00 of their principle back earlier.

Cruiser's avatar

Quicken Loans suggests you call your lender to inform them of your intention to send in extra monies to be applied to principal only. Here is an article they wrote that is full of excellent tips, do’s and don’t’s about what you are trying to do.

Strauss's avatar

Sending it all in one payment should not be a problem as long as you are sure the lender will apply the extra funds to the principle.

Zissou's avatar

It’s PRINCIPAL, not PRINCIPLE. These are two different words. The above posters give good advice, but as Strauss said, don’t assume. Check the terms of your loan and see what they say about early repayment, and also contact your lender to make sure they will direct the extra funds where you want them to.

JLeslie's avatar

You will shorten the length of the loan and save some interest, but it will not reduce your payment amount monthly. If you pay $1200 a month, you always will, even if you pay more to the principal. You just will pay that amount for fewer months than the original plan.

If you think you might ever be tight on money in the near future I recommend not paying extra principal, because you must pay the $1200 a month.

The two times I’ve paid off my mortgage I just waited until I saved up a bunch, I did the math to see if it made sense to give up the tax write off, and then I just paid off the loan balance completely in full when I was ready.

I agree with everyone who said if you do pay extra into the principal make sure you write on the check exactly what that money is for. You may want to call who holds your note and ask them specifically what you should do, and verify the benefits specific to your loan.

tedibear's avatar

@ZissouTHANK YOU!!! I mentioned the use of the incorrect word in my post, but because I—whispered I guess it got ignored.—

Allie's avatar

@Zissou @tedibear Ha, sorry both. I guess interest principal is the only principal that ISN’T your PAL. ;) A memory trick from school has failed me.

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