How does paying extra on my mortgage affect my amortization schedule?

Question

I am a first time home buyer and have some spare cash after my home purchase to pay forward quite a bit of money (cash was not available during actual purchase, so, no, I could not have put it towards the downpayment). I just want to make sure I understand precisely what happens with my amortization schedule if I pay extra/ahead of time. My mortgage is $300k at 3.7% interest (30 year fixed). Here is the first few months in the schedule: My question is, let's say I pay both November and December's principal in November (ie paying $913.10 in principal + November's $925.00 interest). Does my new schedule look like this? The key question being that the $923.59 interest from the original schedule's December just completely disappears? (Perhaps the resulting principal/interest in the post-November months would change since technically the balance is now lower... but I'm not fussed over the specific mathematics on that point). I am expressly asking does the $923.59 interest from December permanently go away?. Phrased more generally, does paying month x,y,z's principal forward permanently remove month x,y,z's interest (where x,y,z are months that are not the current month)?

Answer 1

If you prepay your mortgage you reduce the principal balance, reducing the interest due next month and every month forward. If you prepay $1000 on your mortgage, the interest next month will be reduced by 1000*3.7%/12=3.08 You will still make the same payment, but an additional 3.083 will be credited toward principal. The month after that the principal will be 1003.08 lower than shown on the original schedule, the interest will be reduced by 1003.08*3.7%/12=3.09 and so on. If you sell the house, the payoff of the mortgage will be reduced by the reduction in principal and you will get the money back. If you don't sell the house, the last payments are deleted from the loan and you get your money back that way.

You can create a new amortization schedule in a spreadsheet. A good way to think about it is that you are depositing the $1000 in a savings account at 3.7%. The interest is taxable if you itemize deductions, nontaxable if you do not. If you prepay $1000 after one year, it compounds up to 1000(1+3.7%/12)^(29*12)=2919.32 at the end of the loan, so you will save two payments and a little bit of a third. You get your money back when you sell the house or pay off the mortgage. If that is an attractive investment to you, go ahead and prepay the mortgage. I would point out that this is the cheapest money you are likely to borrow (except for promotional loans on things you buy).

If you prepay next month’s principal, you will remove one payment from the end of the loan. If you prepay the next three months principal, you take three payments off the end.

Answer 2

Interest does not "disappear", but it is reduced in proportion to your outstanding principal balance.

Interest accrued in a pay period (month) = Principal balance * Interest rate (monthly)

It sounds like this is what you probably meant. In your example, Dec-19 interest is reduced to what Jan-20 interest would have been without the extra payment.

Answer 3

People already answered, but the point is you have a flaw in your thinking. December interest is not interest on december's principal payment amount. You're paying interest on $300k (which is why it's so much), not on $450 (which would be 200% interest per month), your december interest is reduced by about 0.3% (3.7%/12) of $450 (the additional principal you're paying) which is about $1.50

Answer 4

Yes. One 'trick' to paying your mortgage in an accelerated fashion is to use the amortization schedule, and pay 'next month's principal. That puts you a month ahead on the schedule. Put another way, if you math it, take that principal, and inflate it by applying the interest rate over the time til the current last payment, you'll see they match up. i.e. 1.037^30*457.25 = 1359.92 (close enough?)

To be clear, when you pay one month principal ahead, you literally move that extra month along on your amortization table.

Answer 5

The interest payment does not "go away", but the amount you have to pay will be reduced. Each month, the amount of interest accrued is based on the remaining balance; a smaller balance means less interest.

You can calculate a new row in the table/schedule the following way:

• Interest = 0.003083 * previous balance (result of previous payment)
• Payment = amount planned for payment (make sure this is at least the minimum due expected by your lender)
• Principal paid = payment - interest
• Remaining balance = previous balance - principal paid

Here, 0.003083 is an approximation of the monthly interest rate (3.7% divided by 12 months).

Answer 6

Others may have made this clear already, but it's an important point: Distinguish between prepaying and paying additional principal.

In the US, the default is often that additional money sent to the bank is just a deposit to be held against future months' payments. As such, they certainly reduce your risk of missing a payment, but do not actually shorten or reduce the cost of the loan.

If your loan permits additional payments against the principal without penalties (not all do), and if you have made it sufficiently clear that this is your intent, that does actually reduce how much you owe and result in your paying off the loan earlier and paying less total interest. You can calculate it using the same kind of amortization formulas as before; if you like you can think of it as refinancing at the same rate and monthly payment but with that much less borrowed, solving for how long the loan will run and what it's total cost will be.

In fact it isn't wholly uncommon for folks to take out, for example, a 30-year mortgage but to try to make the larger payments that would be due for a shorter time period, eg 15 years. That finishes paying off the loan in about 15, years at a cost not very different from having gotten a 15-year loan at the same rate in the first place, while always giving them the option to pay less in a given month if cash flow is tight at the cost of moving the loan a step back toward the 30-year base version.

But, again, this requires that the terms of the loan let you pay down the principal this way, and that you make sure that every payment is clearly marked as being the loan payment plus additional money to pay down the principal. And it's a good idea to read your statements carefully to make sure they did what you requested rather than taking it as pre-deposit against future payments.

(Pre-deposit has its uses too, of course -- if you're going to be clout if the country for a while, it protects you from missing payments and being penalized for that. But it doesn't actually reduce the cost or duration of the loan.)

If this sounds worth investigating, your bank's loan department can help you run the numbers to see how much difference it will make. Or you can play with amortization calculators and see the effect.

Answer 7

The answer will, in part, depend on the country you are in, in part, on the actual terms and conditions of your contract, and in part, on the regulatory structure the lender is required to operate under.

Having worked in this area for a segment of my life. None of us can actually tell you the answer.

For a scheduled balance loan in the United States, yes, that is approximately how it would work if you paid precisely on the due date. I can think of contracts where that would not be true though you no longer see them in much use in the United States.

The reason it may not work that way is that you may have a prepayment penalty, and you may not have the correct number of days in the calculation. A prepayment penalty may reduce the amount that goes to the principal. Also, some places have 360 day years and 30 day months while others have actual days in the actual year, and some have actual days in a 365 day year with no leap days.

I would tell you to see your loan officer, but they most likely have no idea. Their job is sales. They rarely have back-office knowledge because it isn't their job.

There are contracts, rare now in the United States, where the interest is precomputed so that you pay the same amount of interest no matter how much you pay or when you pay. There is no such thing as a principal reduction in any ordinary sense. Your original amortization schedule happens no matter what your behavior is. If you had a precomputed contract, then if you were supposed to owe $1000 in interest in January 2020, then no matter what you do, except paying the loan off, you will owe $1,000 in interest in January. Even you had paid the loan down to one penny; you would still owe $1000 in interest.

Get your contract, deed of trust or mortgage out and read them. Get a printout of recent payments. That will give you a hint as to how many days are being used in a month and in a year. The best indicator is February. If the actual number of days is used then it will be a low interest month. If it is 30/360 it will behave differently. Most U.S. states require precomputed contracts to be spelled out in Truth-In-Lending statement or consumer finance protection statement. Prepayment penalties will be spelled out in multiple places.

Finally, there have existed, I am not sure if they still exist, contracts that do not permit prepayment. Partial payments may go to the escrow account or sit out as an unapplied credit waiting for the rest of the money to complete a full payment amount. The money would just sit there doing nothing until it accumulated enough to be a full payment. Then it would be applied when that payment came due.

Outside the United States, there are a number of interest calculation structures that are not used, nor are they similar to those used in the United States.

Simple interest is almost never used in the United States and is banned in some jurisdictions for mortgages.

EDIT One additional thing, separate out any principal reduction and clearly mark it principal reduction. If you do not, it may be applied to something else. I might pay it in person.

If I had any concerns, I would do a small principal reduction and see how it affected loan behavior.

From the bank's point of view, you signed a contract to pay 360 payments of a certain amount on a certain date. Unless it says otherwise, you did not sign a contract allowing you to vary your behavior from the stated terms.