When you pay your mortgage each month, some of the money gets applied to the principal, or the amount you borrowed, and the rest goes toward interest. The ratio of principal to interest changes over time. In the first several years of your loan term, most of your monthly payments will go toward interest. As time goes on, more of each payment will be applied to principal.
If you have extra money available, you can make principal-only payments in addition to your regularly scheduled payments. You can pay extra principal on a regular basis or when you receive a bonus, overtime pay, an income tax refund, a gift, an inheritance or funds from another source.
Benefits of Paying Down Your Principal Ahead of Schedule
When you make principal-only payments, all that extra money will go toward the amount you borrowed. That will help you build equity faster and pay off your loan early.
Making principal-only payments can significantly reduce the total amount of interest you’ll have to pay because your interest charges are calculated based on your outstanding principal balance. Paying off the principal faster might save you thousands of dollars in interest over the life of the loan.
What You Should Know About Principal-Only Payments and Regular Monthly Payments
Making principal-only payments can help you pay off your mortgage ahead of schedule, but it won’t change the amount that you’re required to pay every month. If your goal is to have lower monthly payments, you can pay a lump sum to reduce your principal balance, then recast your mortgage. The lender will recalculate your monthly payments based on the amount of principal you still owe and your interest rate. You might have to pay a fee to recast your loan.
Things to Consider Before Making Principal-Only Payments
Paying off your mortgage early and paying less in interest can seem like a great idea, but it might make more sense to use extra money in a different way. Consider your other debts and their interest rates, the amounts you have saved for retirement and emergencies, and your long-term goals to figure out how to best use the additional funds you have available.
Some lenders charge prepayment penalties. If yours does, making principal-only payments might not save you much when you take the fees into consideration.
If you make extra payments, notify your lender and ask the company to apply the money to your principal. If you don’t, the lender might apply those payments to interest instead.
