I have a 16,000.00 loan at 6.49%. If I pay 6,000.00 on the principal, will it lower my payment? Will it reduce interest each month and reflect on my payment?
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7Sometimes you can even choose! I had a mortgage that every time I made a down payment, they asked me if I wanted to reduce the total duration or the monthly payment.– lvellaJan 20, 2021 at 13:36
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3This question needs a country tag! Otherwise, no answer is possible.– AganjuJan 21, 2021 at 4:42
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5Not an answer, just some advice - make sure when making a large payment that you ARE paying on principal and you are NOT doing a "pre-payment" - some banks will just hold on to your money and make your payment for you. You don't earn interest on that pre-payment, and it does not lower your loan interest. In my opinion, it's dirty - but if banks are notorious for swindling people with confusing terms, I don't know who is.– corsiKaJan 21, 2021 at 17:06
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2@Aganju In this case, the terms of the loan contract would focus the question better than the jurisdiction of the contract.– LawrenceJan 21, 2021 at 23:17
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1In France, you have to pay extra interest if you are paying in advance. And then you can choose between recalculating your monthly rate but keep the same deadline, or lower the deadline while keeping the monthly rate. And then I (vaguely) heard that in the United States, paying in advance will allow you to lower the amount of interest that would pile up, effectively lowering the monthly rate. This is definitely country specific.– ClockworkJan 22, 2021 at 15:11
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6 Answers
In many cases, the loan payment is fixed, but you'll reduce the loan term and total interest paid by making early principal payments. Suppose you've borrowed $10k, to be repaid over 10 years, with a $100 monthly payment. Paying some amount of principal up front typically won't change your monthly payment at all (you'll still owe $100/month), but the time to repayment will be shortened (so you might finish paying off the balance after only 8 years). The net effect is that the total amount of interest paid decreases, as does the proportion of each payment that goes toward interest. The total amount paid each month stays the same, but a larger portion of it goes toward paying off the principal, rather than paying interest. This is one of the most common loan arrangements, but do check your loan details or contact the bank if you are unsure.
With this in mind, you can see that making early payments may not be the right move in all situations. An early principal payment is in a way "locked in" to the loan, and won't yield any tangible benefit until much later, when the loan gets paid off early. In the 10-year loan example I gave, an early payment on Day 1 will change nothing about the loan except its payoff date. If that early payment moves the payoff date up by 2 years, you still have to wait 8 years until it will affect your monthly cash flow in any way. Early principal payments do increase the amount of principal paid more quickly, however, which can be useful if you're refinancing the loan or selling the underlying asset - you're effectively banking the saved interest immediately by concluding the loan.
answered Jan 19, 2021 at 21:10
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3Paying early can be tangible before the loan is paid off it you refinance or sell the underlying asset. Jan 19, 2021 at 21:34
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9True that making extra principle payments usually doesn't pay off until you get to the end of the loan term. But it can pay off big. More of your payments goes to principle instead of interest, which means that the next payment you reduce the principle even more. Effectively you're collecting compound interest. It's like saving for retirement: I wouldn't say that saving for retirement is a waste of time because you won't get the benefit for 40 years. It's called "planning ahead".– JayJan 20, 2021 at 3:38
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Plenty of ways to get tangible benefit besides waiting for the loan balance to go to zero. You can sell the home, or open a HELOC. Jan 22, 2021 at 15:02
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While there is no benefit to cash flow there is a benefit to your financial position as you are reducing the debt faster at that point. Jan 28, 2021 at 5:55
Most loans are "fixed payment". (CC is the primary counter-example.)
Thus, you must make the same payment every month.
Each payment reduces the principal (fancy word for "balance due"); thus, for each payment, the amount applied to the principal increases, and the amount which goes to the interest decreases.
Since interest is calculated based on the balance due, an extra payment reduces the balance due and thus you pay less interest:
WARNING: read your loan agreement! They might have added sneaky fine print which invalidates our answers.
BOTTOM LINE: it's almost certainly a good idea to make extra payments.
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1The important conclusion: The extra payments don't change the monthly amount due, but reduce the number of payments remaining.– Hart COJan 19, 2021 at 23:32
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6Re your bottom line, maybe yes, maybe no. For instance, if I have a mortgage at under 3% (and not paying PMI &c), it's probably not a good idea to sell off my mutual funds (returning a long term average of 7-8%) to pay off the mortgage.– jamesqfJan 20, 2021 at 2:47
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To your last line - I've spent too many hours explaining that paying off 18%+ credit card debt is better than paying a 5% mortgage early. The claim was that $100 paid to the mortgage saved $400+ 30 years hence, but the 18% credit card was going to be paid down over 5 years, so $100 there only saved $200. I'd highly recommend Oversimplify it for me: the correct order of investing for a look at where this might be in one's priority. Jan 20, 2021 at 11:12
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3Re "sneaky fine print", my first car loan had that. It had some weird schedule that defined how early payments would be applied that had nothing to do with the interest rate or remaining principal. I replaced it as fast as I could with a conventional loan, because the terms got less favorable the longer I held onto it. Jan 20, 2021 at 22:44
As everyone said, it fully depends on the loan contract. The lender may want to guarantee themselves you pay debt and interests.
Let me add a little maths. In Europe, the French system is widely used in load, particularly on house loans. Every principal is computed as
where r is the repayment amount, i is the interest rate, C is the capital owed.
In this case, every principal consists of a capital part and interest part. The key thing is that
- Early payments are made most of interests
- Interest are computed over residual capital
- Interests-over-interests (late payments) are not considered
Here is an example. Euro currency was added by Excel but it can be any currency. (60000€ on 6% APR)
| # | Residual debt | Principal | Interest | Capital |
|---|---|---|---|---|
| 0 | 60.000,00 € | 0,00 € | 0,00 € | 0,00 € |
| 1 | 58.474,68 € | 1.825,32 € | 300,00 € | 1.525,32 € |
| 2 | 56.941,74 € | 1.825,32 € | 292,37 € | 1.532,94 € |
| 3 | 55.401,13 € | 1.825,32 € | 284,71 € | 1.540,61 € |
| 36 | 0,00 € | 1.825,32 € | 9,08 € | 1.816,24 € |
(I had omitted boring rows, get the full plan here)
As you can see, on first principal you will pay 300 of interest while the last consists only of 9 of interests.
If you pay down a large amount earlier, subsequent principals will be recomputed. The total owed capital is reduced, and thus the due interest. Depending on the loan contract, you can either reduce the duration of the debt, but keep principals constant, or reduce principal amount but keeping the same duration.
In the end, you will save interests unless you have some down-payment fees.
If, conversely, your loan is computed over the full owed money (borrowed capital + interest, divided by installments), then you won't be saving any interest and you should invest the extra money you own to get additional money.
answered Jan 20, 2021 at 12:56
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1@Ivella r=repayment amount, i=rate of interest (period appropriate of course), C=Capital, and n=number of repayment periods– illustroJan 20, 2021 at 17:33
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@illustro I thank you for providing the information I forgot Jan 20, 2021 at 19:05
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@usr-local-ΕΨΗΕΛΩΝ not a problem. It would be good if you could include them in the answer, as comments are generally quite ethereal on stackexchange– illustroJan 20, 2021 at 22:50
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Maybe the French system is different, but in the English I know the "principal" part of the payment is the part you've labeled "Capital". That is, the "principal" part of the payment is the part that reduces the remaining balance on the loan. Added to that is interest. Jan 22, 2021 at 15:07
I am a bit surprised by the other answers that assert that early payments can only reduce the term, but not the cost of each payment.
This is not true, at least in Japan. I have a mortgage and a car loan (with different banks), and both let me make early payments. In both cases, they let me choose how to apply my payment: whether to lower the monthly payment, or reduce the amount of payments.
Also, these loans specified that they allow early payments without penalty, which most likely means there are other loans that impose a penalty.
Just like everybody else said, please check the terms of your loan, to get an authoritative answer. Alternatively, contact the customer support department, and ask them!
As for whether or not to actually make early payments, you should consider, among others:
- The loan interest rate
- How much you think you can put your money to grow if you hadn't paid the debt early
- The depreciation or appreciation of the item you are getting with your loan
- Other special issues, like tax incentives for having a specific type of loan (there is a tax incentive for having certain types of mortgages here in Japan)
- Your cashflow
- Your peace of mind of having fewer loans
In my case, I sometimes make early payments in my car loan, to reduce the amount paid each month, and help a bit with cashflow, but I'm not in a rush, since the interest rate is really low.
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My mortgage (UK, pretty standard), like yours lets me choose, after making a substantial overpayment, whether to reduce the term or the monthly payment; I think the latter is the default.– giddsJan 21, 2021 at 0:02
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Indeed, my student loans in the US would recalculate monthly the amount due to maintain a fixed end date. They were variable rate so it was necessary anyway, but the end result was if I put extra money to the principal, the monthly payment went down.– PGnomeJan 22, 2021 at 14:50
As others have said, check the terms of your loan, carefully. The most likely answer is that it will shorten the term of the loan without affecting the amount due at subsequent payments, but terms vary widely; it's not even guaranteed that your overpayment will all be applied to principal -- some loans carry a prepayment penalty that penalizes you for paying early.
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This is the only answer that doesn't make assumptions about country and type of loan, which are not at all specified in the question. +1 Jan 22, 2021 at 15:09
You have to read your contract but in general, no.
Watch out for a prepayment penalty or early payoff penalty in your contract as this would affect your decision to make early payments.
Your payment will stay exactly the same but next month's payment will go less towards interest, more towards principal, and you are effectively shortening the lifespan of the loan.
If you want your loan to be recalculated then you would be interested in recasting.
A mortgage recasting, or loan recast, is when a borrower makes a large, lump-sum payment toward the principal balance of their mortgage and the lender, in turn, reamortizes the loan. This means that your loan is reduced to reflect the new balance.
Recasting cuts your monthly payments and the amount of interest you’ll pay over the life of the loan. It does not, however, affect your interest rate or the terms of your loan.
https://www.bankrate.com/mortgages/what-is-mortgage-recasting-and-why-do-it/
When recasting you keep the same interest rate. If you're looking to benefit from an interest rate reduction or shorten (higher monthly payments)/lengthen (lower monthly payments) your loan term, then you would be interested in refinancing.
answered Jan 20, 2021 at 13:39
