How Loan Payments Work
Have you ever wondered how the payments you make on your loan are being applied to your balance? When you make a loan payment, assuming there is interest accruing on the loan, part of the payment goes toward interest, and the rest goes towards the principal balance. Read on to learn more about principal balances, interest accrued, loan advances, and much more.
What is Principal Balance?
The principal balance is the exact balance of the loan, not counting any interest accrued or fees added. This is the amount financed when your loan was finalized and will be adjusted over the term of the loan. As you make your loan payments, the principal balance begins to decrease until the loan is paid down to zero. Your principal balance can also increase if there are loan advances transacted on the loan.
What is a Loan Advance?
A “loan advance” is additional borrowed funds added to your original principal balance.
A loan advance on an auto loan can come in many forms. One example is adding ancillary products to your auto loan, like GAP (Guaranteed Asset Protection) or a warranty. Another example is financing your sales tax after the loan was finalized. Adding a loan advance will result in a higher monthly payment or a remaining balance after the maturity date (the date that your loan is set to be paid down to zero).
For a credit card, loan advances are more commonly referred to as “cash advances.” This occurs when funds are withdrawn from the available credit on a credit card. This is mostly used when funds are needed for a purchase, and the cash is pulled from the credit card rather than from a checking or savings account. When you take advantage of a cash advance on your credit card, interest begins accruing immediately. To avoid paying unnecessary interest on cash advances, be sure to utilize your credit card as a point-of-sale transaction.
How is Interest Accrued on a Loan?
When you make a traditional loan payment, not all the payment goes toward the principal balance of your loan—some of it is being applied to interest that has accrued. The amount of interest that has accrued is calculated using this formula:
- Annual Percentage Rate ÷ 365 = Daily Percentage Rate
- (Current Principal Balance X Daily Percentage Rate) X number of days since the last payment has been made.
For example, the current Principal Balance on your loan is $15,490 with an Annual Percentage Rate of 12.99%, and the last payment you made towards your loan was 30 days ago.
First, calculate the Daily Percentage Rate (12.99% ÷ 365) to get your Daily Percentage Rate (0.000356)
Next, take 0.000365 X $15,490 = $5.51 (how much interest accrues per day at that balance)
Finally, take $5.51 X 30 days = $165.38 in interest is owed
As you begin making the first few payments on your loan, more of your payment will go towards interest because the balance on the loan is larger. As the principal balance gets paid down, the amount of interest you owe decreases. This is why it is important to pay down your principal balance as quickly as possible, to avoid paying additional interest. See Principal Only payments below for more details.
What Are my Payment Options at BluCurrent?
A regular, or traditional, payment being applied to a loan will satisfy any amount of fees owed, interest accrued, and the rest will be applied to the principal balance. These are the regularly scheduled monthly (or semi-monthly, biweekly, or weekly) payments required to satisfy your loan payment as you agreed to when you signed the paperwork for your loan.
Principal Only Payment
A principal only payment is an additional payment that can be made—on top of the regular payment—that specifically applies 100% of the payment to the principal balance on your loan. If you can apply principal only payments to your loan you can pay down the loan faster, thus avoiding paying as much interest. It is important to note that principal only payments will not satisfy interest accrued on your loan or roll forward the payment due date. They are not intended to replace a regular payment.
The other payment option allows you to pay a certain amount towards your loan that is less or more than your regular payment and can be used to satisfy your regular payment. This option is useful if your payment was $198/month and you wanted to round it up to an even $200. Your regular payment will be satisfied, and any additional funds, if paid prior to your due date, will be applied towards the principal balance, paying down your loan faster. If additional funds are paid after your due date, they will be applied towards your next payment due as a “partial payment”.
Have questions about how BluCurrent Credit Union in Springfield, MO can help you achieve your financial goals? Contact us and a friendly BluCurrent representative would be happy to help!