ELI5: overpayments on personal loans

Homerboy

Lifer
Mar 1, 2000
30,859
4,976
126
I'm looking at taking out a low interest personal loan to pay off some higher interest rate loans (CCs and the like)
That being said, I could afford the fastest pay back window (2 years) but it would be pushing the monthly budget. I'd prefer to take a 3 year loan at a slightly higher percentage and overpay as much as I can every month. This way if I have some unforeseen expenses, I can skip the overpayment that month and still be in good standing.

I wanted to make sure the overpayment went to principal though and this was the response:

"Yes, you have the ability to make additional payments towards your loan without penalties. Please keep in mind that when making an additional payment, it will go towards interest first, then towards principal. "

I'm confused that it goes towards interest first.... what interest? If I make the FULL fixed payment amount that month. And then throw another $100 in with it (or even later in that month) is it going towards the overall principal still owed on the loan? Or would my next month payment just be $100 lower? Or ???

Thanks... sorry. I'm dumb with things like this :(
 

local

Golden Member
Jun 28, 2011
1,851
515
136
I'm looking at taking out a low interest personal loan to pay off some higher interest rate loans (CCs and the like)
That being said, I could afford the fastest pay back window (2 years) but it would be pushing the monthly budget. I'd prefer to take a 3 year loan at a slightly higher percentage and overpay as much as I can every month. This way if I have some unforeseen expenses, I can skip the overpayment that month and still be in good standing.

I wanted to make sure the overpayment went to principal though and this was the response:

"Yes, you have the ability to make additional payments towards your loan without penalties. Please keep in mind that when making an additional payment, it will go towards interest first, then towards principal. "

I'm confused that it goes towards interest first.... what interest? If I make the FULL fixed payment amount that month. And then throw another $100 in with it (or even later in that month) is it going towards the overall principal still owed on the loan? Or would my next month payment just be $100 lower? Or ???

Thanks... sorry. I'm dumb with things like this :(

Sounds like a car loan, overpay and owe less for next month but still owe the same total, not a mortgage where you overpay and owe less overall. From what I understand everything but a mortgage works like the car loan.

The benefit is once overpaid enough you can skip a month or two of car payments whereas the minimum mortgage payment is always the same until you owe $0.

I am not very smart with this either so you probably shouldn't listen to me.
 
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Grey_Beard

Golden Member
Sep 23, 2014
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Sometimes loan interest is calculated daily. In that case, if you pay one payment on time, then submit a second, interest will still be accrued. Of course this will mean when you make your payment again, more of that payment will go toward principle. They are required to let you know that the interest is take first from payments over the principal. Also, as you pay more principal, the interest will also decrease and your monthly payment will go to more principal. This is the advantage of paying a bit more. The 3 year term with an additional payment is good financial management, just be disciplined in making the additional payment.
 
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highland145

Lifer
Oct 12, 2009
43,910
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Typically an installment loan with a set number of payments. If you make 5 at once, your next due date is advanced 5 months. The interest charges may be pre computed and continue every month as scheduled. You have to pay it off to save any $.
 

Homerboy

Lifer
Mar 1, 2000
30,859
4,976
126
Sometimes loan interest is calculated daily. In that case, if you pay one payment on time, then submit a second, interest will still be accrued. Of course this will mean when you make your payment again, more of that payment will go toward principle. They are required to let you know that the interest is take first from payments over the principal. Also, as you pay more principal, the interest will also decrease and your monthly payment will go to more principal. This is the advantage of paying a bit more. The 3 year term with an additional payment is good financial management, just be disciplined in making the additional payment.

Thanks - they clarified a little more too for me:

"That is correct. In that scenario, the extra $100.00 would not lower the following moths payment, but would go towards paying down the total amount due on the loan. "

If my monthly payment is a fixed $500, even if I pay $5,000 in a month, I still owe $500 next month. But my overall balance goes down $4,500 so it seems. But that seems like "principal first"... i guess unless there is daily interest as you outlined.

Regardless of which way it is applied, it's still in my direct benefit to pay more every month so that the number of months is shortened.
 

Grey_Beard

Golden Member
Sep 23, 2014
1,825
2,007
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Thanks - they clarified a little more too for me:

"That is correct. In that scenario, the extra $100.00 would not lower the following moths payment, but would go towards paying down the total amount due on the loan. "

If my monthly payment is a fixed $500, even if I pay $5,000 in a month, I still owe $500 next month. But my overall balance goes down $4,500 so it seems. But that seems like "principal first"... i guess unless there is daily interest as you outlined.

Regardless of which way it is applied, it's still in my direct benefit to pay more every month so that the number of months is shortened.

Yes. They cannot charge more than the documents you were provided that outlined total interest. The best way to look at it is, if you are to pay $500 per month, then $50 goes to interest and $450 to principal. If you pay the extra $100, then $10 goes to interest and $90 to principal. When you pay the $500, $40 goes to interest and $460 goes to principal. This is a simple example to help you understand the machinations. Realize that if you pay the $100 with your regular payment, this will be different, but I wanted you to see the details.

In these cases, the balance each day is X and then the interest is applied. On day 10X, if a payment is made that balance is lower, therefore the interests is lower for the next payment as the daily balance for the next 20 days is lower.
 
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Homerboy

Lifer
Mar 1, 2000
30,859
4,976
126
Yes. They cannot charge more than the documents you were provided that outlined total interest. The best way to look at it is, if you are to pay $500 per month, then $50 goes to interest and $450 to principal. If you pay the extra $100, then $10 goes to interest and $90 to principal. When you pay the $500, $40 goes to interest and $460 goes to principal. This is a simple example to help you understand the machinations. Realize that if you pay the $100 with your regular payment, this will be different, but I wanted you to see the details.

In these cases, the balance each day is X and then the interest is applied. On day 10X, if a payment is made that balance is lower, therefore the interests is lower for the next payment as the daily balance for the next 20 days is lower.

Thanks. I think it makes (enough) sense to me now.
 
Nov 8, 2012
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Simple Interest vs. Compound Interest

Also

How car loans calculate interest
Most loans (for example, a mortgage or a student loan) charge compound interest. Many car loans, however, compute interest differently—they charge simple interest.
What’s the difference between compound interest and simple interest?
Compound interest is charged on both the principal and accrued interest amount. That means that as your interest balance increases with each day that the loan is outstanding, interest is also charged on that balance.
Simple interest is calculated based only on the principal balance outstanding on the loan.
The good news is that simple interest results in a lower interest charge over the life of the loan. In fact, the simple interest calculation can save several hundred dollars over the full term of the loan.