Every month you pay your mortgage, part goes to interest and part to principal. Paying extra reduces the principal faster, which means less interest over the life of the loan. The savings can be significant, especially for long-term loans.
How Mortgage Prepayment Works
When you make an extra payment, it reduces your principal balance immediately. Future interest is calculated on this lower balance, so every payment after that costs less. The effect compounds over time, like a snowball rolling downhill.
The Calculation
The interest saved depends on three factors: how much you prepay, when you prepay, and your remaining loan term. Paying $10,000 extra in the first year of a 30-year mortgage saves dramatically more than paying the same $10,000 in the 20th year, because there's more time for interest to accumulate on that principal.
Should You Prepay?
Prepayment makes sense if: (1) Your mortgage rate is higher than what you'd earn in a savings account or investment. (2) You have a lump sum that won't be needed for emergencies. (3) You prefer the certainty of guaranteed interest savings over the risk of market returns.
Prepayment might not make sense if: (1) You have higher-interest debt (credit cards, for example). (2) You could earn more by investing the money. (3) You need that cash buffer for opportunities or emergencies.
Tips for Prepayment
- Call your bank first to check if there are any prepayment penalties
- Apply extra payments directly to principal, not just reducing the next payment
- Consider automating small monthly extras, which add up over time
- Recalculate your loan term after significant prepayments to see how much time you've saved