Can You Make Principal Only Payments on a Mortgage?
Explore how making principal-only payments can significantly reduce your mortgage interest and shorten your loan term.
Making principal-only payments on a mortgage is possible for homeowners seeking to reduce their total interest paid and accelerate their path to full homeownership. A typical mortgage payment, known as PITI, encompasses four main components: Principal, Interest, Taxes, and Insurance. While principal and interest directly repay the loan and its cost, taxes and insurance are usually collected by the mortgage servicer and held in an escrow account, from which they are paid on your behalf.
Understanding Principal-Only Payments
A principal-only payment is an additional payment specifically directed to reduce the outstanding principal balance of your mortgage loan. Unlike a regular monthly payment, where a portion covers accrued interest and the remainder reduces the principal, a principal-only payment bypasses the interest component and directly targets the amount you originally borrowed.
When you make an extra payment, clearly designate it as a principal-only payment. If not specified, extra funds might be applied to the next month’s regular payment or held as unapplied funds, rather than directly reducing your loan’s balance. By reducing the principal, you lower the base upon which future interest charges are calculated, leading to long-term savings.
How to Make Extra Principal Payments
To ensure any extra funds are correctly applied to your mortgage principal, contact your mortgage servicer. Many servicers offer methods like online portals, phone calls, or written instructions. When using an online portal, look for an option to apply extra funds directly to the principal balance.
If paying by check, clearly write “principal only” on the memo line and include a separate note if required. Check their website or contact customer service for instructions, as some servicers have specific forms or procedures. After making an extra payment, verify through your statements or online account that the funds were applied to the principal as intended. Strategies include sending one extra mortgage payment annually, making bi-weekly payments (resulting in one additional monthly payment per year), or consistently rounding up your monthly payment and applying the difference to principal.
Impact of Accelerating Principal Payments
Making extra payments directly to your mortgage principal reduces the total interest paid over the life of the loan. Since interest is calculated on the remaining principal balance, lowering this balance faster means less interest accrues over time, saving you significant money.
Accelerating principal payments also shortens the overall loan term. For example, consistently paying an extra amount each month can shave years off a 30-year mortgage, allowing you to become debt-free sooner. As the principal balance decreases, your home equity—the portion of your home that you truly own—increases at a faster rate. This enhanced equity can provide financial flexibility.
Key Considerations Before Making Extra Payments
Before committing to extra principal payments, review your mortgage contract for any prepayment penalties. While less common on conventional mortgages, some loans might include clauses that charge a fee for paying off a significant portion or the entire loan early. These penalties are calculated as a percentage of the outstanding principal balance or a certain number of months’ interest, and apply within the first few years of the loan term. However, small, consistent extra principal payments do not trigger these penalties.
Maintain an adequate emergency fund. Have three to six months’ worth of living expenses saved in an easily accessible account before dedicating extra funds to mortgage principal. This fund acts as a safety net for unexpected events, such as job loss, medical emergencies, or significant home repairs, preventing the need to incur high-interest debt or risk missing mortgage payments.
Prioritize higher-interest debts, such as credit card balances or personal loans, over mortgage principal payments. Interest rates on these other debts are higher than mortgage rates, so paying them off first yields greater interest savings. Extra principal payments do not affect the escrow portion of your mortgage payment, which covers property taxes and homeowners insurance. These payments will still be due as scheduled, and their amounts can fluctuate independently of your principal balance.