Published December 08, 2010
Most mortgage payments include a portion that's applied to the principal and a portion that's applied to interest. It might seem mysterious, but it's easy to find out how your lender calculates these amounts and by how much an extra payment will shorten the time to your payoff date.
The answer is found in your mortgage amortization schedule, which is a breakdown each month of how much of each payment is applied to the principal and how much to interest.
By the numbers
A typical mortgage amortization schedule shows the month (or number) of each payment, total payment amount, principal paid, interest paid, a running tally of your total interest and the remaining loan balance. As payments are made, the principal and total interest increase while the monthly interest paid and the loan balance decrease.
The easiest way to create a mortgage amortization schedule is to use an online calculator. First, enter the mortgage amount, term and interest rate. With a click, the calculator generates a schedule of how the payments are applied. Some mortgage calculators also allow the user to estimate the effect of additional payments.
Extra payments won't lower the monthly payment. When an extra payment is applied, the money is applied directly to principal. The result is that more of each subsequent payment is applied to the balance and less is applied to interest, so fewer payments are required. The benefit is not immediate savings, but rather a lower total interest cost and closer payoff date.
Prepayment: not always worthwhile
For example, an extra payment of $10,000 on a 15-year loan of $65,900 with a 6% interest rate wouldn't lower the $556 monthly payment, but it would cut the interest expense from $34,200 to $22,080 in round numbers. That's a savings of approximately $12,000. The loan would be paid off in a bit less than 12 years, cutting more than three years of payments from the end of the term.
The shortened term would be shown on the mortgage amortization schedule.
Some experts advise homeowners not to make extra payments unless they have other financial resources for emergencies and have prepared for their retirement years. That's because extra money applied to a mortgage now is no longer available for unexpected needs, and because the savings you might realize will not grow in the same way that a traditional investment compounds.