What Happens If You Pay 1 Extra Mortgage Payment a Year?
Uncover how a single annual extra mortgage payment can significantly shorten your loan term and reduce overall interest costs.
A mortgage represents a significant financial commitment. Homeowners frequently seek strategies to manage this debt and shorten its repayment period. Understanding how mortgage payments are applied can reveal opportunities to achieve financial goals sooner.
Understanding Mortgage Amortization
Mortgage amortization refers to the process of gradually paying off a loan through regular payments. Each scheduled monthly payment is carefully structured, with a portion allocated to cover accrued interest and the remaining amount applied to reduce the outstanding principal balance.
Early in the loan’s term, a larger share of each payment typically goes towards interest, reflecting the higher principal balance. As time progresses and the principal balance decreases, a greater proportion of each subsequent payment is directed towards reducing the principal. This shift occurs because interest is always calculated on the remaining loan balance. Any reduction in the principal balance immediately lowers the base upon which future interest charges are calculated.
Calculating the Impact of One Extra Payment
Making one additional principal payment each year can significantly accelerate a mortgage payoff and reduce the total interest paid over the life of the loan. This strategy directly impacts the loan’s amortization schedule by reducing the principal balance faster than originally planned.
Consider a hypothetical 30-year fixed-rate mortgage of $200,000 at an annual interest rate of 6%. The regular monthly payment for this loan would be approximately $1,199.10. Over the full 30 years, the total interest paid would be around $231,675.
By consistently making one extra payment of $1,199.10 each year, either as a lump sum or by dividing it into smaller monthly additions, the loan term can be substantially shortened. This single additional principal application per year could reduce the loan term by several years, often between four to eight years, depending on the loan’s specifics. This can result in tens of thousands of dollars in interest savings.
Implementing Extra Payments
Homeowners have several methods for making additional principal payments on their mortgage. Many lenders offer online portals or mobile applications that allow borrowers to designate extra funds specifically for principal reduction. Alternatively, you can mail a check with clear instructions to apply the payment solely to the principal balance. Always explicitly state that any extra funds are for principal only, preventing the lender from holding them for future payments or applying them to escrow accounts.
One common strategy is to make bi-weekly payments. Instead of 12 monthly payments, bi-weekly payments result in 26 half-payments annually. Another approach involves dividing the regular monthly payment by 12 and adding that amount to each of the 12 scheduled payments. Regardless of the method chosen, confirm with the lender that the extra funds are correctly applied to the principal to ensure accelerated payoff benefits.