Looking to finance a car but will be able to pay off principal over time. Since loans are structured to pay off interest first, how’s is my rate changed based on the interest I have already paid? Is that money lost or will my new monthly payment account that I owe less money and I’ve paid for more interest than I actually needed to (assuming rates are the same)
If I pay off principal on a loan, how does that impact future payments based on interest I have already paid
DebtMost car loans are set up based on the following criteria:
- Total amount financed (or principal)
- Interest rate
- Number of monthly payments
These criteria set your monthly minimum payment. Once they are set, the interest rate and the monthly payment are set for the duration of the loan.
Interest is charged on a monthly basis, based on the remaining principal. Assuming no late payments, the monthly payment should always cover the interest accrued, plus some principal. That is why, at the beginning of the loan, the largest percentage of your monthly payment is going to interest, but over time, it trends towards principal.
Assuming there are no prepayment penalties, paying extra on principal will reduce the principal for the next interest calculation, that is how it saved you interest. And it also means a larger percentage of your monthly payment goes towards principal, not interest.
Paying extra on the principal does not change the monthly payment. It either means you pay off the loan sooner, or they apply it to the next due date. So when you do make an extra payment, a lot of times you need to be very specific to tell them to apply it to the principal, not the next due date.