Principal Payments
You may have noticed a line on your payment coupons for your mortgage or car loan that says, “Principal Payment.” You may have wondered what exactly a principal payment is, and how it differs from the regular payments you send in every month. Doesn’t all the money you send in for payments go to the same balance?
Yes, the money does go to the same balance, but principal payments actually designate where the payment goes. Here is how your usual payments work, unless you have an interest-only loan: Your payment is received and applied to your balance, but it is also applied to the interest your loan has accrued since the last payment was received. So if you have a remaining balance of $800, and send in a payment for $50, you might think that your remaining balance will become $750 after the $50 payment, but unless the payment is a principal payment, this won’t be the case.
Principal refers to the actual balance that you owe without any additional interest or fees attached. If you did not pay interest and fees in the last statement cycle, then these amounts become part of your principal balance too, resulting in you paying interest on previous interest. This is one of the ways creditors make their money. Paying interest on interest can result in a lot of money.
Your payment is comprised of two parts: principal and interest. If you have a mortgage loan, there may be additional parts to the payment including taxes and insurance. When you send in a payment, money is distributed to both principal and interest unless you specify otherwise. Your regular monthly payment should be this way because you can’t just choose to not pay interest, but a principal payment is the way to go if you are making extra payments. Why? The more you pay down on principal, the less overall interest you will wind up paying. This is because the amount of interest you pay is directly related to your principal balance. If your principal balance is $12,000, you pay interest on that full $12,000. Pay that principal balance down to $10,000, however, and you’re only paying interest charges on the $10,000. It’s a very basic concept.
Whenever you make a principal payment, you reduce the balance more substantially than you would if you allowed the payment to be applied to both principal and interest. If you send in an extra payment, specify that you want it applied to the principal balance otherwise your lender will probably apply it to both. If you send in an extra payment in the hopes of skipping the next month’s payment, however, a principal payment won’t work because it won’t replace your next payment. If you don’t realize this, you might wind up delinquent on your loan.
Try to make additional principal payments when you can. These specific payments will shorten the amount of time it takes you to pay off your loan and will reduce the overall cost of the loan.




