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As others have insinuated, for an auto loan, the difference between making an early payment in the monthly cycle vs on the due date is miniscule. If they want to minimize the interest payments, they should make extra principle payments. This has the greatest effect on the total interest.
The extra or additional funds should be specified for principle payments and not for future monthly payments. The extra principle payments will allow him to clear his car note earlier than expected.
This is true. But considering that most sell their homes long before any standard mortgage term has been satisfied, I'd wager that the big benefit to this method for most would be in owing less overall (via interest) and, thus, being able to recoup more money in equity, etc., when they do sell.
Very true. Even if they don't get it paid off, at least they'll owe considerably less and therefore have considerably more equity in the house if/when they sell it in 6 to 10 years (or whatever). That will make the financial transition to their next house considerably easier.
There seems to be very little information online about this exact topic- most articles are in regard to making extra payments or more frequent payments. Any info from someone familiar with this would help. Thanks.
Use this amortization calculator and follow along with me.
Enter the following items from the figures you posted.
Payment amount 550
Annual interest rate 5.5
Number of regular payments 60
Payments per year 12
Check the box - show amortization schedule
Click on calculate
You should end up with a beginning loan amount of 28794.06
The schedule of payments gives you a breakdown of interest and principal as each payment is made.
This calculator assumes that all payments are POSTED to the account on the same day every month.
Your question was: "Does the timing of each monthly payment actually reduce interest over the long run?"
The answer is no, it doesn't, not significantily.
Example: First payment of $550 made on Sept 1. Next payment is due Oct 1 but is made Sept 15. Yes, the amount of interest is lower for that payment because you are only being charged for 15 days. So, what happens if you make the Nov payment on Oct 15 (two weeks ahead)? What happens is you are charged interest from Sep 15 to Oct 15 (a full month). If payments are made regularly two weeks ahead of the due date, each payment will have a full month's interest charged.
If your relative wants to get the loan paid off early and reduce the total amount of interest paid over the life of the loan, your relative should make the payments at the same time every month but add some to each payment so the extra is applied to principal.
In the above example the total interest paid over the life of the loan is 4205.94.
Adding 25 to each payment (paying 575) reduces the total interest to 3990.63 and shortens the loan payoff by 3 months.
Not very significant but let's add 100 to each payment (paying 650) reduces the total interest to 3490.94 and shortens the loan payoff by 10 months.
Many people just don't realize the benefit of paying EXTRA on their mortgage loan in the early years of the loan. This is especially true the higher the interest rate is that they are paying. If their mortgage interest rate is only 3% or so, then I wouldn't be in any big hurry to pay it off. OTOH, if their mortgage rate is closer to 7% or more, then extra payments early in the life of the loan can knock YEARS off the total repayment time.
While interest rate certainty play a role it’s the length of the loan that is the pivot point. Even at 2% interest borrowing for 30 years is impacted greatly by princ payments early. It’s simple math but has less to do with rates vs duration
You nailed it. It does NOT work like a mortgage. They use a daily simple interest formula, so interest accrues on a daily not monthly basis. If it was monthly like a mortgage then the timing of a payment would be irrelevant as long as it is paid by the due date. On a daily formula, interest accrues each day, so the earlier in the cycle you pay, the lower the interest you pay for that cycle. However, if you go much beyond one monthly cycle, the benefits of paying early diminish. The only lasting benefit seems to be the extra principle reduction from the first month, and each month after is based on a lesser principle amount.
My last car payment (haven't had one for several years) worked exactly like my mortgage. Both are simple interest.
I paid off a 5-year car loan in a bit over 2 years, which saved me a lot in interest (and almost 3 years of payments that I didn't want to stretch out). I'm doing the same with my mortgage, and I can see every month how the calculations work (i.e., that the daily interest currently being charged is based on the NEW balance after my last payment). And interest accrues daily on my MORTGAGE too; it has on every mortgage I've ever had.
Your posts are a bit confusing as the logic of the interest rate is exactly the same on many loans, and I would be very surprised if that's not the case for your relative. Yes, paying earlier reduces a simple-interest car loan by a bit, but because car loans typically aren't anywhere near what people have for mortgages, the savings are much lower too so harder to see (or, apparently for some, to see the benefits of).
Thanks to everyone for the responses. I've sort of become an expert on this topic since my first post. The auto loan is structured on a 360/365 day schedule, meaning interest accrues daily, not monthly (like a mortgage). Since interest accrues daily based on the outstanding principle amount, the earlier you pay in the monthly cycle, the less interest you pay overall since the next payment is calculated on a reduced principle amount.
The loan contract lays out the starting principle amount, monthly payment amount (minimum due), and interest owed over the life of the loan. The loan contract interest figure assumes that the borrower pays only the minimum due and pays exactly on the due date each month. However, However, if the borrower deviates from that pattern the figures change.
A borrower who pays earlier in the cycle will pay less interest than specified on the loan contract and may payoff their loan early compared to someone who pays exactly on the due date each month. Even one early payment will have an impact. This is without making any additional principle payments.
My last car payment (haven't had one for several years) worked exactly like my mortgage. Both are simple interest.
I paid off a 5-year car loan in a bit over 2 years, which saved me a lot in interest (and almost 3 years of payments that I didn't want to stretch out). I'm doing the same with my mortgage, and I can see every month how the calculations work (i.e., that the daily interest currently being charged is based on the NEW balance after my last payment). And interest accrues daily on my MORTGAGE too; it has on every mortgage I've ever had.
Your posts are a bit confusing as the logic of the interest rate is exactly the same on many loans, and I would be very surprised if that's not the case for your relative. Yes, paying earlier reduces a simple-interest car loan by a bit, but because car loans typically aren't anywhere near what people have for mortgages, the savings are much lower too so harder to see (or, apparently for some, to see the benefits of).
You may be right. The goal is to reduce interest as much as possible within the given structure, and possibly payoff the loan sooner than scheduled, without having to make any extra principle payments. If this can be accomplished then its worth it. The relative's budget can accommodate moving forward the payment timing, but adding extra principle payments would be too disruptive to their finances and questionable since they have a low interest rate of sub-5%.
Thanks to everyone for the responses. I've sort of become an expert on this topic since my first post. The auto loan is structured on a 360/365 day schedule, meaning interest accrues daily, not monthly (like a mortgage). Since interest accrues daily based on the outstanding principle amount, the earlier you pay in the monthly cycle, the less interest you pay overall since the next payment is calculated on a reduced principle amount.
Again: interest accrues daily on most mortgages as well. Not sure why you think interest accrues monthly on a mortgage?
Quote:
Originally Posted by SoundAdvice4U
The loan contract lays out the starting principle amount, monthly payment amount (minimum due), and interest owed over the life of the loan. The loan contract interest figure assumes that the borrower pays only the minimum due and pays exactly on the due date each month. However, However, if the borrower deviates from that pattern the figures change.
A borrower who pays earlier in the cycle will pay less interest than specified on the loan contract and may payoff their loan early compared to someone who pays exactly on the due date each month. Even one early payment will have an impact. This is without making any additional principle payments.
The way interest works, I cannot see one early payment having an impact more than a few dollars. I'd have to see an amortization schedule but logically, it doesn't make sense.
Can you give us some figures? Because again, this doesn't make any sense to me, and I am generally good with numbers.
Quote:
Originally Posted by SoundAdvice4U
You may be right. The goal is to reduce interest as much as possible within the given structure, and possibly payoff the loan sooner than scheduled, without having to make any extra principle payments. If this can be accomplished then its worth it. The relative's budget can accommodate moving forward the payment timing, but adding extra principle payments would be too disruptive to their finances and questionable since they have a low interest rate of sub-5%.
But if the payment is, say, due on the 15th of each month and they make it on the 1st instead, then they are paying a tiny bit less interest for about 2 weeks. If each of their subsequent payments is also made on the 1st, they likely won't save anything more in interest because it's still 30 days from their LAST payment (so in other words, on subsequent payments, they're still paying a full month's worth of interest that accrued since their last payment).
So except for saving a tiny bit of interest in the first month that they pay early, I'm not seeing how they could have any saving substantial enough for them to pay off the loan even 1 month early?
Again: interest accrues daily on most mortgages as well. Not sure why you think interest accrues monthly on a mortgage?
The way interest works, I cannot see one early payment having an impact more than a few dollars. I'd have to see an amortization schedule but logically, it doesn't make sense.
Can you give us some figures? Because again, this doesn't make any sense to me, and I am generally good with numbers.
But if the payment is, say, due on the 15th of each month and they make it on the 1st instead, then they are paying a tiny bit less interest for about 2 weeks. If each of their subsequent payments is also made on the 1st, they likely won't save anything more in interest because it's still 30 days from their LAST payment (so in other words, on subsequent payments, they're still paying a full month's worth of interest that accrued since their last payment).
So except for saving a tiny bit of interest in the first month that they pay early, I'm not seeing how they could have any saving substantial enough for them to pay off the loan even 1 month early?
You may be right on mortgages. If they operate on a similar 360/365 daily accrued interest structure, then they are similar to the auto loan scenario.
There are numerous amortization calculators available online, but none seem to address this issue. You would need a calculator that allows one to plug in differing dates of payment to compare scenarios, otherwise it is useless. If someone knows of one please provide a link.
One early payment may have a minimal impact of only a few dollars THAT MONTH, but would also reduce interest each month thereafter. Even if only by a few dollars. Each subsequent monthly payment is calculated on the new remaining principle balance, so if the principle balance is reduced sooner, less interest is owed and a larger portion of each subsequent $500/mo payment goes towards principle. The more that goes toward principle, the sooner the loan is paid off.
If one consistently pays early on the cycle as opposed to later, they would save interest over a 5-year auto loan term and would possibly pay off the loan early. That is really the point here. If a $500/mo payment must be made no matter what, why not try to avoid paying some unnecessary interest, even if its only a few bucks?
Last edited by SoundAdvice4U; 10-01-2023 at 07:47 AM..
You may be right on mortgages. If they operate on a similar 360/365 daily accrued interest structure, then they are similar to the auto loan scenario.
There are numerous amortization calculators available online, but none seem to address this issue. You would need a calculator that allows one to plug in differing dates of payment to compare scenarios, otherwise it is useless. If someone knows of one please provide a link.
One early payment may have a minimal impact of only a few dollars THAT MONTH, but would also reduce interest each month thereafter. Even if only by a few dollars. Each subsequent monthly payment is calculated on the new remaining principle balance, so if the principle balance is reduced sooner, less interest is owed and a larger portion of each subsequent $500/mo payment goes towards principle. The more that goes toward principle, the sooner the loan is paid off.
OP, you seem to think that because every payment is being made early, they would continue to save lots of interest every month and maybe pay the loan off early. But because each payment after the 1 first early payment is still being made 30 days later, then they're still paying a full month's worth of interest after the first early payment. That's how simple interest works.
First month of the loan: call it a 5-year loan for $30,000 at 3.5% interest. An amortization table shows us that in the first month, if the loan is paid on day 30 as expected, the $545.75 monthly payment would consist of $458.25 to principal and $87.50 to interest. If instead the loan is paid on day 15 INSTEAD OF day 30 in the first month of the loan, only about $43.75 in interest will have accrued (half of the first month's interest of $87.50), so the first payment would actually go $502 to principal and $43.75 to interest. So in the first month, yes, there would be a bit of savings on interest ($43.75) and the balance would go down to $29,498 instead of the $29,541.75 it would be if the payment were made on day 30 as expected.
But after that, the savings is negligible -- some pennies per month. Here's why:
Second month: paid 30 days from the previous payment, so there is 1 full month of interest due (yes, the payment is being made 15 days early again, but it's still 30 days from the previous payment). The interest is on a balance of $29,498 ($30,000 minus $502) instead of $29,541.75 ($30,000 minus $458.25) that it would be if the first payment had been made at 30 days instead of 15. At .292% interest for a month (that's 3.5%/12), the savings on the $43.75 difference equals less than 13 cents. So 13 cents is saved in month 2.
Same thing for subsequent months. After the first month, you're only saving the interest on the $43.75 that your balance was reduced by in month 1 (as if you'd made an extra payment of $43.75) plus the 13 cents that you saved in the next month. In the 3rd month, it would be savings on the interest on $43.75 plus 26 cents, and so on -- so after the first month, it's really negligible.
(Note, I used monthly interest instead of daily, but that would make a few pennies' difference at the most. The principle of what is happening is the same.)
Quote:
Originally Posted by SoundAdvice4U
If one consistently pays early on the cycle as opposed to later, they would save interest over a 5-year auto loan term and would possibly pay off the loan early. That is really the point here. If a $500/mo payment must be made no matter what, why not try to avoid paying some unnecessary interest, even if its only a few bucks?
Yes, they WOULD save a few bucks, almost all of it in the first month because they were essentially making 1 extra payment of half a month's interest (the $43.75). But after that, if they continue to pay 30 days later, they save just a few more pennies each month.
THAT is why making just 1 payment 15 days early wouldn't amount to much -- while paying a FEW DOLLARS EXTRAeach month would work because it would reduce the principal by extra $ every month. So THAT is what I would suggest they do!
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