Individuals around the world take out different kinds of loans for many different purposes. Each loan is a unique contract between the lender and the borrower. Evaluating loans must take place on a case-by-case basis. However, there are certain conventions that have become somewhat universal in terms of lending. One of these is the process that many borrowers use to pay off loans early by putting extra money toward the principal of the loan. For those who are looking at how to pay extra for the principal of a loan, these are some of the most common steps recommended by lending experts and those who have experience in working with lenders on existing loan products.
1Budget in a higher payment. One of the first steps in planning to pay extra for the principal on a loan is to make sure that you are able to afford these bigger payments.Ad
2Research your loan for prepayment penalties. Prepayment penalties are clauses inserted into the loan by the lender that punish borrowers for paying loans off early. Look for these terms in the fine print of your loan, or ask lender representatives to clarify whether they apply.
- Understand why lenders might attach prepayment penalties. While it might not make sense to some borrowers, the idea behind prepayment penalties is that early payoff on loans can diminish the total amount of interest that the lender receives. Classically, prepayment penalties were a way to recoup some of this money. In some lending communities, they are no longer common, as many consider them unfair to the borrower.
3Get realistic about your expectations for paying off principal. Some borrowers think that additional principal payments will reduce their monthly payments on a loan. This rarely happens because of a process called amortization. Instead of applying a smaller payment, the lender shortens the term of the loan when the principal is paid early. Evaluate loan amortization with an amortization calculator to more fully understand this process.
4Communicate with your lender. When you make payments on principal, coordinate them by communicating with lender representatives. Negotiate the timing for early principal payments and make sure that they will be used toward principal, rather than set aside and used on the next monthly payment or applied toward interest.
5Consider refinancing a loan. One way to establish early payment is to refinance the loan with a shorter term. However, many borrowers prefer to just pay extra on the existing loan, since refinancing can lead to much higher required payments each month.
- Always be aware of fees for refinancing. Some lenders push refinancing as an attractive option without specifying costs that may get folded into future monthly payments. Read any refinancing agreements carefully before going this route to reduce loan interest over time.