Friday Financial Foul Ups: Speeding Up Payments on Loan Interest, Not Principal

This week’s Friday Financial Foul Up will feature a post by Evan.  Evan, a 27 year old married lawyer blogs over at My Journey To Millions about personal finance and estate information.  If you like this foul up, take a minute and give Evan a follow over at twitter (@MJTM)  Enjoy his story and hopefully you learn from his mistake (after reading this, I know I am going to call my car loan company to see how my loan is set up).

If you would like to add your own financial foul up to this series, please contact me here.
_________

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

The Situation

So my car was dead, but living and working in the suburbs of Long Island, No car was not an option.  Even though I didn’t have a personal finance blog at that point I decided to make a reasonable car purchase.  What does Reasonable mean for me?  I had three options

  • A late model 2006 Mitsubishi Sedan with 9,000 miles;
  • An amazing 2006 Cadillac CTS with 15,000 miles or so;
  • A New Ford Edge

Well I heard the usual

I was a professional I needed a professional car

Get the New Car you can afford it

You will make more money eventually, etc.

As you can probably get from the tone, I went with the reasonable 2006 Mitsu Sedan.

Where I Fouled Up

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 I ‘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?  When I looked at my account for the first time in months (my second foul up), 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.

What I learned

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. Just make sure the loan doesn’t have a prepayment penalty.

———-

Do you like this series? Check Out The Previous Foul Ups:

Foul Up #12 – Elle (Couple Money) – Stretching Yourself to have a Comparable Car to Your Friends
Foul Up #11 – Revanche (A Gai Shan Life) – Sibling Bailouts Cost More than Just Money
Foul Up #10 – Brad (Enemy Of Debt) – There’s Nothing Interesting About Interest-Only Loans
Foul Up #9 – Jason (Redeeming Riches) – Buying a Car with a Balloon Payment at the End
Foul Up #8 – David (Money Under 30) – Being Too Eager to “Move Out” and “Move Up”
Foul Up #7 – Matt (Debt Free Adventure) – Upside Down and Paying The Price
Foul Up #6 – Brian (MyNextBuck) – Overdue Books Prevent Me From Renting an Apt
Foul Up #5 – Kelly Whalen (The Centsible Life) – Poorly Planned Vehicle Purchase Costs $24,000
Foul Up #4 – Stephanie (Poorer Than You) – Signed My Life Away at Age 17
Foul Up #3 – Deliver Away Debt – How I Wasted Over $10K and 11 Months
Foul Up #2 – Brian (MyNextBuck) – Quick Fixes to Weight Loss
Foul Up #1 – Brian (MyNextBuck) – How I Didn’t Earn $3000 in Free Money

29 Responses to Friday Financial Foul Ups: Speeding Up Payments on Loan Interest, Not Principal
  1. Financial Samurai
    December 18, 2009 | 7:46 am

    Evan, you had the 240SX?! That car was SWEET back in the early 90’s! I totally wanted one of those but couldn’t afford it, so I road my bike to class. The chicks didn’t really dig it.

    13% car loan rate is usurious! Those bastardos!

  2. Evan
    December 18, 2009 | 9:06 am

    FS,

    They were sweet in the early 90’s…to bad I bought it in ’99! Doesn’t matter I LOVED that thing, and have threatened the wife that I will buy another one to keep in the driveway.

    13% was/is Nutty…but I didn’t have a choice, although I have since cleaned up credit report like no other

  3. Financial Samurai
    December 18, 2009 | 8:04 pm

    I also REALLY loved the 1989 Mustang 5.0 GT. I was faced with buying one in the early 90’s during HS but couldn’t come up with the funds. Loved that thing.

  4. MD @ Studenomics
    December 19, 2009 | 9:39 am

    @FS You should have bought one of those bikes with two seats.

    13%? That’s brutal for a car loan. Awesome to hear you have cleaned up the credit report. How’d you do it?

  5. Evan
    December 22, 2009 | 7:14 am

    To be honest, I just got on top of my Stuff, but it actually it was a weird process. I applied through one of those aggregate sites where everyone emails you quotes and they ranged from 10 to 18! 18%?! I put on the app that I was paying 13%? What the hell.

    And then out of no where my still current loan carrier called me and asked in no other certain terms, “what’s up? You aren’t happy?” and I said No I am in double digits, and then they brought me down to my current rate.

  6. Flexo
    December 22, 2009 | 9:11 am

    I encountered the same problem when I was paying off my student loan. They were kind enough to (eventually) ask me which I wanted to do…

    FS: Don’t forget to nominate Friday Financial Foul Ups for the Multi-Part Series Plutus Award! :-) I think it’s a neat idea for a series.

  7. Flexo
    December 22, 2009 | 9:12 am

    Sorry that should be Brian, not FS, I was reading FS’s comment at the time!

  8. Meg
    December 23, 2009 | 2:05 pm

    Evan, the 240SX is STILL a sweet car…. Don’t insult my 19 year old baby like that! :(

    LOL at the odometer, yeah, mine’s stopped working… At 285k miles. The KA and tranny were pulled somewhere past 300k miles, both still working and yes, both original. The reason they were pulled was in favor of my pretty SR20DET. :) (Which, a month later, is still not in working order, ugh. Blown turbo.)

    Totally get another, they are so worth it. 😛 (Wait, that’s bad financial advice, isn’t it? Oops…)

    Last random thought — I’m digging this comment font…. Haha.

  9. Evan
    December 24, 2009 | 9:25 am

    Meg I would NEVER hate on the 240sx! I would LOVE to get another one it would have to be an early 90’s hatchback though. Maybe I can dream one day…

  10. Clayton
    January 1, 2010 | 7:42 pm

    This is great to know since I might be looking for a new car in the upcoming year. I didn’t know you could prepay for interest. I got my Ford F150 in 03 and I’m going to keep it til it dies. It might not be the 240, but it’s perfect for me and at 140k it’s got a long way to go

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