It was a cold winter day in 2006. I was 6 months out of law school working at a firm where I usually stayed till about 7pm. I walked to my trusty, lovable Nissan 240sx. This car had so many miles the odometer literally stopped working (I am not kidding it was stuck on 160k). The hood was dented inward cause it was actually backed up on by a construction truck, and sometimes it didn’t exactly feel like shifting….but boy did I love this car. It was my first car and it survived Senior Year of HS, College and Law school. So imagine my disappointment when I walked to my car that day and it didn’t start. I popped the hood (like I knew what I was looking for) but then I saw it, a large crack down the side of the engine.
It was over for my baby
I have previously discussed my eventual reasonable car purchase, but I learned something today about that purchase. When I bought the car I received a 7 year loan at 13%. As I fixed my credit, I refinanced it down to 9%, but kept my payments the same. I was paying an extra payment of $15 bucks a month and I assumed those payments were going to principal. Any time someone uses the word “assumed” you can assume (cheesy pun intended) that he done messed up. Assuming anything was my first mistake!
Most Auto Loans are Amortized but Your Extra Payments may not be reducing Principal
Wikipedia defines an amortizing loan and amortization schedule as,
While a portion of every payment is applied towards both the interest and the principal balance of the loan, the exact amount applied to principal each time varies (with the remainder going to interest). An amortization schedule reveals the specific monetary amount put towards interest, as well as the specific amount put towards the principal balance, with each payment. Initially, a large portion of each payment is devoted to interest. As the loan matures, larger portions go towards paying down the principal.
Well, what was happening with my Wachovia Auto Loan? Today I looked at my account for the first time in months (my second mistake), and my monthly payments were being reduced, so I quickly thought to myself, “Self, that isn’t supposed to be happening. I am on an Amortization Schedule, as such any extra payments shouldn’t reduce my monthly payment, but rather it should reduce my principal of the last month of the loan.” This is the whole idea of prepaying your mortgage – it is to shorten the time you are paying, and thus reducing the total interest you are paying to the lender.
Wachovia Wasn’t Reducing my Principal on my Auto Loan – They were speeding up the Interest on the Amortization Schedule
When I called the Wachovia Rep, who was very nice by the way, and told him what was going on – he explained to me that they deal with these phone calls often.
I said, “What Phone Call? When the borrower realizes that his extra payments are just paying Wachovia early, rather than reducing his principal faster?” He laughed. The Wachovia Representative explained that their Auto Loan Payment Program isn’t set up to apply extra payments to principal. When I asked Why…he again, laughed. The answer is simple they make more money the way it is being done.
While, I thought I had been doing everything right, like prepaying a debt, and having that payment paid automatically from checking account, I was wrong. So learn from my money story – if you are prepaying any debt make sure your payments are being applied to principal and not just prepaying what the lender originally calculated as your total interest payments.
One Caveat: Just make sure the loan doesn’t have a prepayment penalty.
Want to Play with a Amortization Calculator?
My Journey, thanks for sharing this. My fiance has been doing something similar to you, by making extra payments each month. I emailed this blog post to her, and hopefully we can check to see if a similar thing is occurring.
The hint will be if her payments are getting lowered. Also, tell her to request a new amortization table!
I had a similar experience on my old car loan. Thought I was being smart by paying extra. Then, like you, I saw me next month’s payment was just lowered. Yup, I was paying any more to principal.
I found out that if I wanted to pay principal I had to send the extra payment somewhere else or use a different online payment location. These were sneaky details on my bills which I didn’t take the time to read.
My Journey,
I think it is one of the banks can get a bad name. I had a mortgage I was doing the same thing with. I paid a bonus into the mortgage company they decided to apply the payment to the next two months payments. Within the same month I decided to take some savings and knock the entire loan out. I did this knowing the applied two payments in the future so left the amount of one month’s payment so I would not overpay. Those yahoos decided that I still hadn’t paid the loan completely while they held my future Interest and Principal payments even though it would pay the remaining $300 balance. I called them and let them know they were basically acting like a bank and needed to apply my future payments to my current balance and it would be closed and they could send me the remaining balance. Ended up they wanted me to send them the $300 even though they had two months payments sitting in accrual. After called again and let them know that they would just have to send me a larger check to make it right after the payment I conceded. They sent me a check for $12.00 and said that was the end. They kept payments for two months that hadn’t happened. They contest that they don’t owe anymore than the $12.00 UGH…wish I could find a Lawyer that would take the case based on principal. I would donate the money they owe me…
Bobby
Sometimes it isn’t worth the fight!
Also, if you use online amortization calculator to calculate your car loan monthly payment, you may paying more than you should.
I recently find out my Honda auto loan is 3.966% instead 3.9% on my notes.So, I called, but I was told my interest rate is 3.9% and my loan payment amount is correct. but I have used 4 different online amortization calculator , they all show as 3.966%. when I explain this to the rep, they said they dont know what is going on and I asked them to forward my compaint to proper department and want they recalucate my loan payment, according to 3.9% on my notes, the rep refused. And I refinanced my loan today with the rate 3.45% with otherbank
So, make sure your payment amount is what is should be, run serveral free online amortization calculators.
Wow thats an interesting story…for .66% they lost a customer!
Safe Credit Union in California does the same thing. I have always pre-paid any/all auto loans off (granted usually were thru the dealership i.e; Ford Motor Credit). This time I have a VW Jetta and had made a $1,000 extra payment – I told the teller “I want this to go towards principal” (as I had learned needed to be said from years earlier). Then I got a notice “No payment due for 4 months” – I went into the bank and was politely told “We don’t apply it to principal. This is how we do it.” Ridiculous. My loan is supposed to be for 3yrs. I plan on paying it off next month (7 months from the date of origination.) – OH and I always make sure no prepayment penalty. 🙂
If you have a simple interest loan it doesn’t matter what you tell the teller. I noticed when paying my Chase car loan online, a box where you could put an amount to “apply to principal.” and another box to “apply to payment”
This is a head scratcher because it simply does not matter if you say “Apply to principal” or not, the terms of the loan spell out how your payment is applied
Think about it for a moment. Say your monthly payment is $200 and you pay $400. Say the interest for the month is $25.00 You have paid $25.00 in interest. Where does the remaining $375 go if it is “applied to payment”.
Now, since I always pay extra and put the payment in the “apply to payment” box, my bank statement says my next payment is due in 3 years!!! If i were to take their advice and make no payments for 3 years, my loan amount would slowly but surely climb back up as the interest accrues, to what it was if I made the regular payment each month.
So you see, on a simple interest loan, all they are doing when you pay extra, is giving you permission to skip some payments. They are hoping you will, so the interest will build up.
Nevertheless the payments pay down your principal in the exact same amount regardless of whether you tell them to apply to principal or not.
Now, if you have some sort of low grade loan due to bad credit, you might not be getting a simple interest loan. Maybe you get one with a pre payment penalty. Maybe you get a “pre computed” loan… Pre computed are crappy in that the amount of the interest owed is the same whether you pay ahead or not. When you pay off your loan, then some math is done to repay you any interest you may have made over what you should have . Precomputed loans are illegal in 17 states, and may not be more than 61 months even in the states they are legal.
In any of these loans, it simply doesn’t matter how you tell the teller to apply the payment
Finally,
Someone who knows what they are talking about.
Complicatedly put – if you apply any extra toward the payment schedule instead of toward the principal, you are allowing yourself breathing room in case you are short on a payment. The key here is to make sure to apply the payment to your monthly payment and you must do so emphatically (and best in writing), otherwise it may be applied to principal and not reduce the monthly payment. However, as long as you continue to make THE SAME monthly payment that you are suppose to be making from day one, your loan will pay down as though it was paid directly to principal. But YOU MUST not follow the banks schedule if they do reduce your payment owed or allow you to skip payment – you must continue to pay as you had agreed to on the loan document.
Example:
You borrow 10,000 @ 5% on January 1, and your monthly payment is $300 for 36 months. You pay $600 in February. The loan company (assuming this is not a company in a state that allows interest to be on the front of the loan and no prepayment penalties) may apply the extra $300 to principal and you will continue to make $300 payments until the final payment is adjusted for the extra 300 plus minor interest savings. BUT if you tell them to apply it to March’s payment and then continue to make your payment in March designating it as April’s payment, you will have done the same thing as having had it applied to principal. HOWEVER, if you are late, short on payment, lost your job, or whatever, then you will have buffered yourself for the period of the extra month that you had already prepaid. If you don’t need it and continue to pay as I described, you will save yourself the same amount of money as if it had been applied to the principal.