When you take out a loan, the amount you borrow is called your principal, and that’s what accrues interest. Your monthly payment for the loan normally includes principal and interest. Principal-only payments pay down the loan principal, which when added as an additional payment may help you pay off your debt faster.
Principal-only payments may be an option for some installment loans, such as mortgages and personal loans. However, your lender may or may not allow these types of payments.
Let’s explore what principal-only payments are, how they work and how to decide if they make sense for you.
Principal payments vs. interest payments
When you have an installment loan, you typically need to make monthly payments. In general, part of that payment goes toward paying down the principal balance while the rest goes to paying the accrued interest on the loan.
It’s important to understand, however, that some loans may capitalize interest. In that case, unpaid interest would be added to the principal balance of the loan. So, when paying off the loan, you’d pay interest on accrued interest as well as the principal loan amount.
Making a principal payment
To make a principal-only payment, you’d need to make an extra payment on top of your usual monthly payment that would then go toward the loan’s principal balance. This would help pay off the loan faster than making only the minimum monthly payments Additionally, you may need to follow your lender’s instructions on how to specify that the extra payment is intended for the loan’s principal balance. This could vary by lender, so make sure to confirm the process with your own lender before sending a payment.
Pros and cons of making a principal-only payment
There are benefits to making extra principal payments, but there can be drawbacks worth considering.
Pros
- May help you pay off loans faster: Paying down the principal can help move up the payoff deadline.
- May let you save money long-term: Paying down the principal balance shortens the repayment term, resulting in less overall interest.
- Reduces the portion of your monthly payment going toward interest: This already happens as you get closer to paying off the loan, so principal-only payments speed things up.
Cons
- Must be made in addition to your regular payments: Principal-only payments can be difficult to afford since you also need to stick to your regular payments.
- Doesn't reduce your monthly payment: Your monthly payment won’t change by making principal-only payments.
- You may pay a prepayment penalty: This type of fee can make your principal-only payments less effective. The Citi® Personal Loan has no fees including no prepayment penalty.
Deciding whether to make a principal payment
Before figuring out if extra principal payments make sense, check if it’s an option with your lender. Some lenders may not allow these types of payments and instead place overpayments in an escrow account. That won’t help you save or reduce your principal loan amount.
Calling your lender may help you understand if, and how, an extra payment would apply to your loan. In general, lenders apply payments first to accrued interest, then to the principal balance. A representative may be able to help you apply that payment to the principal balance instead.
Another important factor is whether your loan has a prepayment fee. If your loan has a prepayment penalty, it may not make sense to make a principal-only payment. Some types of loans, such as personal loans, may come with this type of fee. However, it may depend on the lender. For example, Citi’s personal loans don’t have a prepayment fee.
Remember that principal-only payments don’t reduce your monthly payment. You’d still make those payments until the loan is fully paid off. Having an emergency fund in place before prioritizing principal-only payments may help you accomplish your payoff goal while protecting your finances.
Citi offers personal loans to both existing Citi customers and new Citi customers that meet specific eligibility criteria, including an established credit and income history along with additional factors determined by Citi. If you think you could benefit from a Citi Personal Loan, apply online today.
