A few basic terms – loan principal, interest, and interest rate.
The loan principal is the amount of money a borrower receives from a lender.
Interest is the fee that the borrower pays to the lender, for the right to borrow the loan principal.
The interest rate is the rate at which interest is paid to the lender.
The interest rate is usually expressed as a percentage of loan principal for a period of one year.
Alright – enough with the italics.
Interest rates are extremely important, but please take note – the amount of interest actually charged by a lender is based on a percentage of the outstanding loan principal.
In other words – if we reduce outstanding loan principal – we reduce the amount of interest we have to pay over the life of a loan.
When working to get out of debt, I always chose to –
Make minimum payments to all lenders (creditors) – on time!
Make extra, principal-only payments, throughout each month, to a single, specific lender.
Making principal-only payments reduces the average daily balance of a loan, an important factor in determining how much interest is charged, per period, by certain lenders.
Reducing the principal reduced the amount of interest that I paid, over the life of each individual loan, and all of my loans, collectively.
I made sure that any principal-only payments were processed as such, and were not simply treated as prepayments by my creditors.
In the case where principal-only payments are not accepted, I would simply make “payments” to an interest-bearing savings account, and pay the entire loan off early in one big payment.Â This assumes, of course, that the terms of the loan allow for this.
Reducing interest rates is awesome – and I’m all for doing so.Â However, I believe that it is extremely important to focus on the loan principal – the amount actually owed – and reduce it as quickly as possible.
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