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?