Key takeaways:
- The principal of a loan is the original loan balance you agree to pay back before interest is calculated.
- Some borrowers can make extra principal-only payments to help pay down their loan faster. This may help save money on interest over time.
- Principal payments are best for borrowers with extra money and no other high-interest debt.
Definition: A principal payment (also called a principal-only payment) is an extra payment applied directly to your loan’s principal balance which reduces the interest you’ll pay over time and can help you pay off the loan faster.
When you take out a new loan to achieve a financial goal, the last thing you want is to spend more on interest than you have to. To streamline paying off your debt, and potentially save on the cost of the loan, you may want to consider making extra principal-only payments.
Read on to discover how principal-only payments work, the benefits, and what to consider before you make an extra payment.
What is a principal payment on a loan?
A principal payment only lowers the principal balance of a loan. It’s an extra payment applied to the amount you borrowed, not to interest or fees, which helps reduce your loan balance faster and cut total interest costs.
Making principal-only payments is a financial strategy you can use to pay down your loan faster. When you make a principal-only payment, your money only goes toward the principal balance. It does not pay down any accumulated interest.
How a principal payment works
When you take out a loan, the monthly payments you make consist of both the principal and interest amounts.
- The principal is the sum of money you borrowed from the lender. It’s the debt you owe and agree to pay back in a fixed amount of time.
- The interest is the cost of taking out the loan. A lender determines loan interest as a percentage of the principal amount. This is typically based on a variety of factors, including your annual income, credit score, credit history, and current debt.
Your ongoing minimum payments will likely be applied to fees and interest first. Then, the remainder of your payment will go toward the loan principal.
However, if your lender allows it, you can apply an additional principal-only payment to your balance. It’s specifically used to pay down your principal amount without any other loan cost factored in.
Pro tip: Not all lenders allow principal payments, and some that do will charge extra fees. Before deciding to make a payment on your principal, consult your lender to learn more about your options.
Regular payment vs. principal payment: what’s the difference?
A regular payment covers interest, any required fees, and part of your principal. A principal-only payment is an extra amount you send after your regular payment that goes directly to reduce your loan balance.
You typically must make a regular payment on your loan before you can make a principal-only payment.
Regular payments include fees, interest, and a payment made on the principal balance of your loan.
After you make your regular payment, you can then apply principal payments. Any principal-only payment on a loan is considered an additional payoff on the balance. Because the interest is based on the total principal, your interest paid lowers as your loan principal is reduced.
Pro Tip: It’s important to check that your principal-only payments are being applied correctly. After you make a payment, review your statement to ensure your payment was applied to the principal and not interest.
Benefits of making principal-only payments
There are a couple of reasons why making one, or several, principal-only payments can be a good financial move. The benefits of making principal-only payments include:
- You can pay off your loan faster: By making additional payments toward the loan principal, you can shorten the length of your repayment term.
- You can save on interest: Paying down your principal faster can help lower the total amount of interest you pay on your loan. That’s because the more you pay down your balance, the less interest will accrue.
What is a principal payment example?
Let’s say you took out a personal loan for $30,000 at an interest rate of 5% to pay back over the course of 6 years. With $4,786.65 in interest fees, your total owed will be $34,786.65.
When you start making regular monthly payments, you also decide to make an additional principal payment of $250 every month. With each additional payment, you reduce the principal balance of the loan. Because your interest payment is based on the principal balance, your remaining interest amount will be reduced as well.
In this scenario, you’d be saving $1,826.87 because you cut the total interest down to $2,959.78 by paying extra to the principal each month.
Here’s how the numbers compare:
Scenario A — No extra payments
- Total interest paid: ~$4,786
- Payoff time: 72 months
Scenario B — Pay $250 extra toward principal each month
- Total interest paid: ~$2,960
- Payoff time: ~52–55 months
Total interest savings: ~$1,800
Pros and cons of principal-only payments
Making additional payments toward the principal could be an effective way to reduce the overall cost of a loan, but it’s important to understand how it fits into your broader financial picture.
Pros
- Pay down your loan faster: Extra principal payments may reduce the outstanding balance, which can shorten the loan term
- Lower total interest costs: Because interest is calculated on the remaining balance, paying down principal early typically reduces the total interest paid over time
- Build equity more quickly (for secured loans): For loans like auto loans or mortgages, reducing the balance faster increases your ownership stake in the asset
Cons
- Possible prepayment restrictions or fees: Some lenders may charge prepayment penalties or have limitations on how extra payments are applied
- Reduced liquidity: Putting extra cash toward your loan means those funds aren’t available for emergencies, savings, or other financial priorities
- Monthly payment usually stays the same: Even with additional principal payments, your required monthly payment typically does not decrease unless the loan is recast or refinanced
Before making extra payments, it’s a good idea to review your loan terms and consider whether prioritizing debt repayment aligns with your overall financial goals.
Questions to consider before making principal payments
Principal payments seem like a profitable decision. However, when it comes to finances, you should always make sure you understand exactly what you’re committing to. Below are a couple of important factors to keep in mind.
Do large principal payments reduce monthly payments?
No. For most loans, principal payments will not reduce the monthly payment amount you owe. However, contributing more than your monthly loan payment will reduce the loan balance quicker. This may help you save money in interest over the life of the loan.
Does your lender allow principal-only payments on loans?
Some lenders don’t allow principal-only payments. Others will allow these types of payments but charge a fee, such as a prepayment penalty.
The fee amount and how it’s applied can differ by lender, and it could defeat the purpose of making a principal-only payment. That’s why it’s crucial to read the loan contract carefully and speak to your lender before making any principal payments.
Do you have other high-interest debt?
If you have multiple loans, consider prioritizing the one with the highest interest. For example, you may want to focus on paying down high-interest credit card debt first. Doing so may save you more on interest overall.
You might also consider using a debt consolidation loan to combine all your debts into one monthly payment.
Pro Tip: If you’re struggling to pay high-interest debt, consider the advice of experts and seek out a debt management plan.
Do you have funds set aside for an emergency?
As a general rule, it’s important to set aside three to six months’ worth of living expenses in savings in case you lose your job or an emergency expense comes up.
If you don’t have an emergency fund or your savings account is running low, consider building up your reserves before you start making principal payments.
Without financial reserves in place, your loan and all the extra principal payments you contribute could be at risk should something unexpected happen.
How principal payments differ by loan type
Personal loans
Many personal loans permit extra payments without penalty, but policies vary. Extra payments reduce your principal and total interest according to your amortization schedule.
Auto loans
Extra payments typically reduce balance and interest, though some contracts use precomputed interest or penalties; ask whether an extra payment will be applied to the outstanding principal or held as a credit toward future payments.
Mortgages
Most services allow additional principal payments and let you target a specific loan (if you have more than one). Prepayment penalties are less common on recent mortgages but can still exist—check your note and ask your servicer how to designate “principal-only” on your payment.
Are principal payments suitable for your financial situation?
Principal payments can be beneficial for some borrowers, but you should only make principal-only payments if you can comfortably afford it. Consider the advantages of a principal-only payment for your current financial situation, looking at your savings, income, and any additional debt you have.
When in doubt, talk to your lender before committing to a principal-only payment to ensure you understand the terms and conditions.
FAQs about principal payments
Can I make a principal-only payment online?
Often, yes. Many lenders offer an “additional principal” or “principal-only” checkbox or field in their online portal. If you don’t see it, call your lender before submitting the payment and add written instructions in the memo.
How often can I make principal payments?
Usually as often as you like—monthly, biweekly, or occasional lump sums—subject to your lender’s policies. Even small, regular extra payments can reduce interest over time.
Is there a minimum principal payment amount?
Lenders may set minimums for electronic or mailed payments. If no minimum is listed, you can typically pay any amount toward principal. Minimum amounts vary by lender and payment method; small extra payments may be accepted, but confirm any minimums or processing rules with your servicer.
What happens if I only pay principal?
You typically must first satisfy your required monthly payment, which includes interest and fees. Extra amounts beyond that can be applied to principal. Skipping required payments can lead to late fees or default.
Will extra principal payments change my loan amortization schedule?
Yes. Paying down principal faster reduces the balance used to calculate interest, which may shorten your payoff timeline and lower total interest.
Won't affect your credit score¹