I saw a video explaining that principle payments helps save money by paying less interest and paying off your loan faster but I’m still confused as to how.
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Let’s use round numbers and simplify greatly. The big thing isn’t about paying more, but about keeping interest payments down.
You owe $12,000. You make $500 a month payments. You pay interest on what’s left to pay first, so at 10% annual interest you pay $100 ($1,200 yearly divided by 12) and then $400 to what you owe.
Next month you owe $11,600, so your interest payment will be slightly less, $96, meaning $404 goes to pay off the loan. Each month you’re paying off the loan faster because more is going to what you owe.
But say that first month you paid an extra $500. So $100 went to interest and $900 went to pay what you owe. Now you owe $11,100, so the next payment will be $92 to interest and $408 to what you owe.
The faster you drop what you’re paying in interest, the faster you pay what you owe, which cycles back around and drops your interest even more.
On the opposite side, missing that first payment adds that $100 interest to what you owe, which means more of the next payment goes to interest, which means you’re not just a month of payment behind, you now have a higher balance you’ll keep paying interest on.
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