Paying extra on a loan: shorter term or lower payment?

Paying extra on a loan is one of the few guaranteed ways to save: every dollar paid early stops earning interest for the lender. But how much you save depends on what you choose.

A worked example

A 20 000 loan over 60 months at twelve percent a year. Monthly payment: 445; total interest over the term: 6 693. After a year you pay an extra 4 000 toward the principal.

Shortening the term saves about twice as much. The reason is simple: with the same payment, more of each payment goes to the principal, so the debt shrinks faster.

When to shorten the term

If you handle the current payment easily and you have an emergency fund. Then every extra payment does the most work.

When to lower the payment

If the payment squeezes your budget, your income varies or you have no emergency fund. A smaller required payment is a safety margin: in a hard month it is easier not to fall behind, and a late payment costs more than any saving. There is a middle way too: lower the payment and keep paying the difference voluntarily each month. You save almost as much as shortening the term, with the freedom to stop.

When paying extra is not worth it

• No emergency fund. Hand the lender your last savings and the next breakdown becomes new debt. Fund first: emergency fund or debt.
• A more expensive debt. A credit card at twenty-four percent matters more than a loan at twelve: pay extra on the most expensive one first. The order: how to get out of debt.
• Near the end of the term. In the last months of a fixed-payment loan there is little interest left in each payment, so the saving is small.
• A prepayment penalty. Some loans charge a fee for paying early. Check the contract.

How it is done

With many lenders, any amount above the regular payment reduces the principal and shortens the term automatically; others let you choose to recalculate the payment instead. Make sure the extra goes to principal rather than being treated as an early regular payment, which saves nothing. Rules depend on the lender and the contract. Money for extra payments can be gathered separately and paid every few months. Where it might come from: what to do with a year-end bonus.

What it looks like in the app

In Caudal a loan goes in Debts as a debt with a monthly payment and a day of the month. An extra payment is recorded with the Make a payment button for any amount: the balance is recalculated automatically, and the payment leaves your account and shows in the reports. If the lender lowered your monthly payment, change it on the debt and the "how many days your money lasts" forecast on the main screen picks up the new amount. With several debts, a plan with dates keeps the order: how to clear your debts in a year.