Pay extra principal in lump sum to save

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Dear Dr. Don,
I’m trying to pay extra on principal to reduce the length of my loan repayment and am wondering which approach I should take.

On a 30-year fixed-rate loan, is it best to give a once-per-year additional payment of $1,200 or 12 additional monthly payments of $100 each?

George Grapple

Dear George,
It won’t be a huge difference over the life of the loan, but making a once-a-year additional principal payment of $1,200 — especially if the payment is made in the beginning of the year — will shorten the loan more than monthly payments of $100.

That’s because the loan balance is reduced in one fell swoop. The remaining mortgage payments will have less interest due while more of the contractual mortgage payment will go toward repayment of principal.

Using Bankrate’s
mortgage payment calculator, I’ve constructed an example that illustrates the difference between the two approaches.

Frequency of additional principal payment:
  None Annually Monthly
Loan amount $200,000 $200,000 $200,000
Interest rate 6.5% 6.5% 6.5%
Original loan term (months) 360 360 360
Loan payment $1,264.14 $1,264.14 $1,264.14
Additional principal payment 0 $1,200 $100
Adjusted loan term (months) 360 291 293
Total payments $455,089 $397,013 $399,143
Total interest expense $255,089 $197,013 $199,143
Difference vs. conventional:
  None Annually Monthly
Interest expense reduction $58,076 $55,946
Loan term reduction in years 5.75 5.58

So, the difference between the two approaches is a couple of months in loan length and a couple of thousand dollars in interest expense.

It’s important to remember that although you’ll save money overall by paying down your mortgage and reducing your principal balance,
your monthly payment will not decrease.

I think the difference between the two approaches you mentioned is small enough that you can choose which approach is easier for you to manage in your household spending plan.

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