Extra principal won't reduce mortgage payments

 

Dear Dr. Don,
Once a mortgage is set up and I decide to pay extra on the principal, should my actual monthly payments go down?
Thanks,
-- Tom Treatment

Dear Tom,
Additional principal payments on a conventional fixed-rate mortgage reduce the principal balance but don't reduce the required monthly payment. A conventional mortgage is self-amortizing, meaning the monthly payment covers both the interest expense and the repayment of principal. Each monthly payment is split into two component parts, interest expense and principal repayment.

Additional principal payments change the dollar amounts going toward principal and interest in subsequent mortgage payments, because lowering the outstanding loan balance reduces the monthly interest expense. The payment stays the same, but the amount going toward principal increases, reducing the length of the loan and the total interest expense.

The table below shows a comparison between a 30-year fixed-rate mortgage with no additional principal payments, a mortgage with one lump-sum additional principal payment and a mortgage where a small amount is added to each monthly mortgage payment.

I used Bank rate's mortgage payment calculator and the amortization schedule provided by that calculator to arrive at these numbers. It's an easy way to see precisely how additional principal payments reduce interest expense and shorten the life of your loan.

 

Conventional 30-year fixed-rate mortgage

One-time additional principal payment

With monthly additional principal payment

Loan amount:

$ 150,000

$ 150,000

$150,000

Loan term (months):

360

360

360

Interest rate:

6.25%

6.25%

6.25%

Mortgage payment:

$ 923.58

$923.58

$923.58

Additional principal payment:

$0

$1,000.00

$20.00

Total payments:

$ 332,487

$327,130

$319,696

Interest expense:

$ 182,487

$177,130

$169,696

Life of loan (months):

360

354

339

Life of loan (years):

30

29.5

28.25

In this example, a $1,000 one-time payment reduced the life of the loan by one-half of a year and reduced interest expense by more than $5,000. Paying an extra $20 per month shortened the loan by 1¾ years and saved more than $12,000 in interest expense. Decide what you are able to do in your monthly budget, and use the calculator to see how it impacts your loan.

If your goal is a lower monthly mortgage payment, additional principal payments won't help. But if the goal is to pay off your loan early, it's easily accomplished.