What Is a Principal Payment?

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 doesn’t change, the portion of each payment that goes toward interest will decrease faster.

• Total interest savings over three years: $1,220. Although your required monthly payment doesn’t change, less interest accrues because you’re 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, you’ll need to check with your loan servicer to confirm it’s 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 won’t pay down your principal or save you money.

Pros and Cons of Principal-Only Payments

Consider the pros and cons before making principal-only payments on your loans.

Pros

• Pay less interest overall: Paying down the principal generally results in less interest accruing over the loan’s 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 comfortable—you don’t need to commit to paying an additional amount each month.

Cons

• Won’t 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 won’t 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 won’t 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.

Is It Better to Pay Principal or Interest?

Lenders will usually apply your standard payments to the interest and fees that accrued on your loan since your last payment, and any remaining funds go toward the principal. You often don’t have a choice in the matter, but paying off the principal is the ultimate goal. So, if you’re making extra payments, try to tell the lender that you want the money to go toward your principal balance.

If you’ve significantly paid down the balance on your loan, you also might be able to recast your loan. Recasting lets you keep the same repayment schedule and term, but changes your monthly payment based on how much you currently owe.

Although lenders might charge a fee to recast your loan, it could help you lower your monthly payment. It’s also generally a quick and easy process. Unlike with refinancing, you don’t need to apply for a new loan because your current lender is simply changing the loan’s terms.

Learn more >> Should I Pay Off My Mortgage Early?

Improve Your Credit While Paying Off Loans

Extra principal-only payments won’t necessarily have a big impact on your credit scores. But making on-time loan payments and paying down balances can improve your credit over time. You can get your FICO Score and credit report for free from Experian if you want to track your progress. And you might get matched with better credit card and loan offers as your credit improves.