Question: I was looking through my car loan agreement when I encountered an unfamiliar term: curtailment. What does “curtailment” mean and how does it affect my auto loan?
Answer: A car loan curtailment means paying off part or all of your auto loan early. If you pay your loan on schedule, you don’t need to think about this. But if you do plan to pay your loan off before the term is over, check your loan agreement. It should spell out the rules about loan curtailments—for example, if a loan has a prepayment penalty. This would require you to pay a fee for paying off your loan early.
How a principal curtailment works
Paying a loan off ahead of schedule—also called principal curtailment—will help you save on interest. Consider the following scenario: Let’s say you’re buying a car worth $50,000. You put down 20 percent, or $10,000 of the car value, and you borrow $40,000.
At 7 percent interest over a loan term of 60 months, you’ll pay about $7,523 in interest over the life of your loan. That means the total cost of owning your car would be around $57,523 versus $50,000 if you’d paid in cash. Your monthly payment toward your principal and interest will be about $792.
Take a look at the table below, where:
- Years: The number of years that have passed since you took out your loan.
- Interest: The amount of interest paid in the previous 12-month period (e.g. you paid $2,580.66 in interest in the first year).
- Principal: The amount of principal paid in the previous 12-month period (e.g. you paid $6,923.92 toward your principal in the first year).
- Ending balance: The amount you have left to pay at the end of the year.
Years | Interest | Principal | Ending Balance |
---|---|---|---|
1 | $2,580.66 | $6,923.92 | $33,076.08 |
2 | $2,080.13 | $7,424.45 | $25,651.63 |
3 | $1,543.41 | $7,961.16 | $17,690.47 |
4 | $967.90 | $8,536.68 | $9,153.79 |
5 | $350.78 | $9,153.79 | $0.00 |
When you put extra money toward your loan’s principal—or the original amount you borrowed—you reduce the number of payments you’ll make and the amount of time you’ll be charged interest. That saves you money.
Let’s say you receive a windfall two years into your car loan and decide to pay off the remaining $25,651. (Let’s also assume you don’t have to pay any curtailment penalties.) In the previous two years, you paid about $4,660.79 in interest and put about $14,348 toward your principal. Then, you sent $25,651 to the bank. The total cost of your vehicle, including your down payment, is about $54,660.
Now compare that to a scenario where you pay off your loan on schedule. You would have paid about $7,523 in interest. By paying off your loan at the end of the second year, you skipped three years of interest payments, saving $2,862.09.
The savings goes even further if your dealer gives you a lower price when financing versus paying in cash. If you get such a deal, make sure you aren’t subject to any prepayment penalties. If you’re not, then you might be able to both get a lower price for the car and avoid interest payments.
Xuyun Zeng is a content strategist with a wide-ranging content background including tech, journalism, cars and health care. After graduating with highest honors in journalism, Xuyun led a newspaper to win eight awards, helped start an award-winning film industry podcast and has written over a hundred articles about cars repair, state laws and insurance. Prior to joining Jerry, Xuyun worked as a freelance SEO consultant with a mission to create the best content that will help readers and grow organic traffic.
Alice Holbrook is an editor with more than a decade of experience covering personal finance, including car insurance. She\\\’s passionate about creating easy-to-understand content that demystifies intimidating topics for readers. Previously, she worked for NerdWallet, and her work has been featured by Newsweek, The Washington Post and the Associated Press, among others.