Making extra payments to your principal is one of the smartest financial decisions you can make if you hold a long-term debt like a mortgage.
What is a principal prepayment?
When you make your regular monthly payment, a large portion of your money goes toward paying the interest charged by the bank, and only a small fraction reduces the actual debt (the principal). An extra prepayment is an additional payment that goes 100% toward reducing the net debt, with no intermediary fees or interest.
Reduce Term vs. Reduce Payment?
This is the most common question among homeowners. You have two choices when prepaying:
1. Reduce the term (Time): You keep paying the same monthly amount, but the loan ends much sooner. This is the highly recommended option because it saves the maximum amount of interest.
2. Reduce the payment: You keep the original payoff date, but your monthly payment decreases. This is ideal if you are experiencing cash flow constraints and need monthly budget relief.
The Golden Rule: The Time Factor
The earlier you make extra prepayments during the life of the loan, the greater the savings. This is because you halt the compounding effect of the bank's interest in the early stages, when the outstanding balance is at its highest.
- •Tip: Use our Mortgage calculator to simulate your payments and see exactly how many months and money you will save today.*