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What Is a Principal-Only Payment, and How Can You Use It To Pay Off Debt Faster?

Last updated 03/08/2024 by

SuperMoney Team

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Summary:
A principal-only payment is a payment that is made directly toward the loan balance instead of being split between principal and interest. Making principal-only payments can reduce the amount of interest that accumulates on the loan and help you pay off your debt faster. However, not all lenders will accept principal-only payments, so be sure to check with your lender to see if this option is available to you.
Debt is like a pesky mosquito that never goes away. Whether it’s a car loan, a mortgage, or credit card debt, interest often seems to pile up faster than we can get rid of it. The good news is that you have the power to shorten the life of your debt and save money in the process by using one simple trick: making principal-only payments.
If you’re looking into ways to pay off a loan faster by reducing the amount of interest you accumulate, making principal-only payments could be a good option to consider. In this article, we’ll discuss what a principal-only payment is, some of the benefits of making these payments and whether most lenders will accept them.

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What is a principal-only payment?

A principal payment, or a principal-only payment, is exactly what it sounds like: a payment that goes entirely toward paying down the principal balance of a loan.
The principal of a loan is the remaining balance of the amount you borrowed before including interest. Traditionally, whenever you make a regular monthly payment on a loan, a portion of that money goes toward paying down the interest while the rest goes toward the principal balance.
With principal-only payments, on the other hand, all the money you pay goes toward your principal, which effectively reduces the amount of interest that accumulates on the loan. By making principal-only payments on a loan, you can potentially save thousands of dollars in interest and pay off the debt sooner.

Why pay down the principal on a loan instead of the interest?

Interest is like a tax on your debt: the more interest you pay, the longer it takes to pay off the loan and the more you’ll end up paying in the long run. On the other hand, making payments toward the principal will reduce the main amount you owe—and, by extension, the interest that will accrue on it, thus shortening the life of the loan.
For example, imagine you take out a loan for $10,000 with an interest rate of 5%, and the monthly payments are applied evenly to the principal and the interest. If you make a regular monthly payment of $500, only $250 will go toward the principal, leaving you with a balance of $9,750 that will accumulate $487.50 in interest.
However, if you make a principal-only payment, all $500 will go toward paying down the principal. This will give you a balance of $9,500, which will add up to only $475 in interest. In short, by putting all your payments toward your principal, you can end up reducing the interest accrued on the loan, thus making it easier to pay off your debt as soon as possible.

How much money can you save by making principal-only payments?

Imagine you have a mortgage with a $200,000 balance and a 4% interest rate. If you only make the minimum payments every month, you’ll end up paying around $143,739 in interest over 30 years! On the other hand, if you make an extra $100 a month in principal-only payments, you’ll save approximately $26,855 in interest and pay off your mortgage five years sooner.
Payment TypeInterest PaidTime to Pay off Mortgage
Minimum Payments$143,73930 Years
Minimum Payments + $100 Principal Payments$116,88425 Years

What to consider before making principal-only payments

Before you plan to make principal-only payments toward your loan, there are a few factors you should consider, such as the terms of your loan, your financial situation, and any outstanding fees or penalties you may need to pay. Here are a few points to keep in mind when it comes to paying down the principal of a loan:

Prepayment penalties

A prepayment penalty is a fee charged by the lender if you pay off your loan earlier than the agreed-upon loan term. These penalties can make it more expensive to pay off a loan early, so it’s important to consider whether the savings you’d get from making principal-only payments would be worth more than the cost to cover the prepayment penalty.

Whether your lender accepts principal-only payments

Not all lenders will allow you to make principal-only payments. Before you plan to pay down your principal, check with your lender to see if they accept principal-only payments and if any restrictions apply.

Additional principal-only payments

A good way to reduce your interest payments and pay off a loan faster is to make extra principal-only payments on top of your regular payments. If you have any extra money to spare — such as a tax refund, a bonus, or an inheritance — consider using that money to pay down the principal on your loan.

How to make principal-only payments on a loan

In most cases, you can make principal-only payments on your loan either through your online account or by contacting your lender directly. Here are a few of the best practices for making a principal-only payment on a loan:
  • Contact your lender first: Before you start setting aside more money for your loan, call your lender or visit their website to see if they accept principal-only payments. Some lenders may require you to fill out a form or send a written request, while others may allow you to make principal payments online.
  • Make bi-weekly payments: Instead of making a single monthly payment, you can make slightly smaller payments every two weeks. The extra payment you make each month can go directly toward reducing the principal balance, which can help you pay off the loan early.
  • Only use extra funds: As mentioned above, it’s a good idea to allocate any extra cash you might have from a tax refund or a bonus toward principal-only payments on your loan.

FAQ

Is it smart to pay down the principal on a loan?

Yes, paying down the principal on a loan is often a smart financial decision. It can reduce the overall cost of your loan by lowering the amount of interest you’ll pay over time. As a result, making principal-only payments can help you pay off your debt faster and start building equity in your property or assets.

Is it better to make extra monthly payments on the principal?

That depends on your individual financial situation and goals. Some people can afford making bi-weekly payments to pay off a loan faster, while others prefer to make a principal payment only when extra money comes in. Generally speaking, it’s best to allocate as many extra payments as you can afford toward your principal in order to pay off your debt as quickly as possible.

Does paying down the principal on a loan build credit?

Paying down the principal on your loan does not directly affect your credit score. However, making on-time payments on your loan and reducing your overall debt can improve your financial stability, which will have a positive impact on your credit history.

Key Takeaways

  • Principal-only payments are payments made on a loan that are applied solely to the principal balance, as opposed to both the principal and the interest.
  • Paying down the principal can reduce the amount of interest that accrues on the loan, thus making it easier to pay off high-interest debt faster.
  • The best way to pay off a loan early is by making additional principal payments on top of your regular payments. These can be bi-weekly payments or the occasional lump sum extra payment, depending on how much extra money you can afford to allocate toward your loan.
  • Not all lenders accept principal-only payments, and some may charge you a prepayment penalty for paying off your loan balance early. Make sure to check the terms of your loan with your current lender to determine if it makes sense to pay down your principal.
Paying off a loan as soon as possible can help you take control of your debt and bring you one step closer to financial freedom. If you need help paying down debt, it’s a good idea to consult with a financial advisor who can guide you through your specific situation.
Is the interest on your loans piling up faster than you can pay it down? If so, you may want to consider settling your debt. Check out SuperMoney’s guide on whether debt settlement is a good option for you, then use our comparison tool to find the best debt relief companies for your needs!

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