Do Large Principal Payments Reduce Monthly Payments?
Find out if extra mortgage principal payments lower your monthly payment or offer different financial advantages for your home loan.
A mortgage principal payment directly reduces your loan’s outstanding balance, distinct from interest, which is the cost of borrowing. This article explains how extra principal payments impact your mortgage and when your monthly payment might change.
Understanding Mortgage Payments
A typical mortgage payment consists of four main components, often referred to by the acronym PITI: Principal, Interest, Taxes, and Insurance. Property taxes and homeowner’s insurance premiums are often collected by the lender and held in an escrow account, from which they are paid on your behalf when due.
Mortgage loans are structured using amortization. This means your scheduled monthly payment for principal and interest generally remains fixed over the loan’s term. In early years, more of each payment goes towards interest and less to principal. As the loan matures, this ratio shifts, with more applied to principal.
Impact of Extra Principal Payments
Making an extra payment directly to your mortgage principal does not reduce your scheduled monthly payment. Your monthly obligation is set by the original loan agreement and amortization schedule. Instead, these additional payments decrease the overall principal balance faster.
Reducing the principal balance also reduces the interest that accrues. Interest is calculated on the outstanding principal, so a lower balance results in less interest charged. This accelerates loan repayment, leading to a shorter term and savings on total interest paid over the mortgage’s life.
When Monthly Payments Change
While extra principal payments do not alter your regular mortgage payment, certain situations can lead to a change in your monthly obligation. One common scenario is refinancing your mortgage. This involves taking out a new loan to pay off your existing one, often with different terms, interest rates, or loan amounts, which will result in a new monthly payment.
Loan modifications are another instance where monthly payments might change. These are formal alterations to the original loan terms, typically initiated by the lender in cases of financial hardship, and can involve adjustments to the payment amount.
Additionally, changes in the costs of property taxes or homeowner’s insurance can affect your monthly payment if these are included in an escrow account. Your mortgage servicer periodically reviews these costs, and an increase or decrease in taxes or insurance premiums will lead to an adjustment in the escrow portion of your monthly payment.
Making Extra Principal Payments
To ensure any extra funds you send are applied correctly to your mortgage principal, it is important to clearly designate them as “principal-only” payments. If you do not specify, the lender might apply the extra amount as an early payment for future scheduled installments, which would not provide the same interest savings. Many lenders offer options through online payment portals to specify that an additional payment should go directly to principal.
When making payments by mail, you should write “principal only” in the memo line of the check. After making an extra principal payment, it is advisable to verify with your lender or check your online statements to confirm the payment was applied as intended.
Some homeowners also choose to set up recurring extra payments or make a lump sum payment from a bonus or tax refund, always ensuring these are designated for principal reduction.