Extra mortgage payments: what they save and what they cost

Extra principal on a fixed-rate mortgage doesn’t lower your monthly payment. It shortens the loan, and each prepaid dollar stops being charged interest, which works out to earning your mortgage rate (before any tax effect) with no market risk. The cost is access: once the money is in the house, you get it back only by selling or borrowing against the home. Whether that trade is worth it depends on your cash cushion, your other debts and what else the money could earn.

The example throughout uses assumed figures, not current rates: a $320,000 balance at 6.875% fixed with 28 years (336 months) left. The principal-and-interest (P&I) payment is $2,148.47. Taxes and insurance are left out because extra principal doesn’t change them, and so is PMI (how prepaying can end it sooner is covered below). With no extra payments, the loan charges $401,885.33 of interest from here.

How much do extra mortgage payments save?

On the example loan, an extra $100 a month saves $56,964.93 of interest and ends the loan 3 years 4 months early; $250 a month saves $114,998.35 and 6 years 10 months. Interest is front-loaded: in month 1, it is $320,000 × 6.875% ÷ 12 = $1,833.33, so only $315.14 of the payment reduces the balance. An extra $250 raises that month’s principal to $565.14, and since every later month’s interest is charged on a smaller balance, the saving repeats until payoff.

The regular payment is applied first and the extra goes to principal after it. Interest is rounded to the cent each month, and the last payment is whatever clears the balance.

• Savings don’t scale in proportion. $500 a month saves about 3.1 times what $100 saves, not 5 times, because the loan ends sooner and fewer months are left to save on.
• Sooner beats later. $179.04 a month and one $2,148.47 payment at the end of each year add the same amount each year, give or take a cent, but the monthly version saves $3,637.13 more because each piece arrives earlier. That is the arithmetic behind “biweekly” plans: 26 half-payments a year equal 13 monthly payments, the same yearly total as adding 1/12 of the payment every month; if a biweekly service charges fees, subtract them from the saving. If the yearly amount is in hand at the start of the year, paying it at once (payments 1, 13, 25, …) saves more than spreading it: $94,198.41, with the loan repaid in 270 months.
• You can aim at a date. Subtract your payment from the payment for the shorter term on your current balance. A 20-year payment on $320,000 at 6.875% is $2,457.00, so the extra is $308.53. Paying exactly that leaves $1.60 for month 241 because of cent rounding; at $309 a month the loan is repaid in month 240 and saves $132,331.82.

Does it matter when you make the extra payment?

Yes, a lot. A prepaid dollar stops being charged interest for every month left on the loan, so the same $10,000 saves far more early on:

The rate the $10,000 earns is 6.875% in every row. What shrinks is how many years it earns it. That is also why the big “interest saved” totals above are not a return figure: they add up dollars from decades apart.

Do extra payments lower your monthly payment?

No. The Fannie Mae/Freddie Mac uniform fixed-rate note (Form 3200) says a partial prepayment changes neither your due date nor your monthly payment unless the lender agrees in writing. A prepayment of principal therefore doesn’t count as next month’s payment, and prepaying doesn’t let you skip one later. Your own note may word this differently, so check it.

A lower payment takes a recast (also called re-amortization): after a lump sum, the servicer recalculates the payment on the smaller balance over the remaining term. The note doesn’t require the lender to agree, so ask your servicer whether it recasts, the minimum lump sum and the fee. Suppose $25,000 is paid today, taking the balance to $295,000:

Recasting frees $167.85 a month. Keeping the payment saves $84,503.67 more interest and ends the loan 5 years 5 months sooner. Refinancing is a third route, with a new rate, a new term and closing costs; the refinance break-even calculator compares it with keeping your loan.

Is it better to pay off the mortgage early or invest?

Investing comes out ahead only if it earns more than your mortgage rate after tax, because that rate is what an extra payment earns, with certainty. Compare rates, not totals. Each month, the gap between the balance with extra payments and the balance without them grows by interest at the loan rate plus the new extra payment, which is exactly how an account earning that rate grows with regular deposits:

• $\Delta B_k$ is how much lower the balance is after $k$ months.
• $E$ is the extra paid each month.
• $i$ is the monthly rate: 6.875% ÷ 12.

With $250 a month for 10 years, the balance after payment 120 is $222,853.45 instead of $265,828.24: $42,974.79 lower. The formula gives $42,974.82; the 3 cents are monthly rounding. Investing the same $250 a month with monthly compounding gives the values below (assumed returns before tax, not predictions).

Five things move the answer:

• Risk. The prepayment return is fixed while you hold the loan. Investment returns are not; a portfolio that averages 9% over the long run can do worse than 6.875% over a particular decade.
• Taxes. The mortgage interest deduction applies only when you itemize on Schedule A. If you do, part of each interest dollar can come back at tax time, so prepaying earns less than 6.875% after tax; if you take the standard deduction, it earns the full rate. Investment returns may be taxed too, depending on the account.
• PMI. If you pay PMI on a conventional loan, extra principal can also bring forward the date you can ask to cancel it: once the balance reaches 80% of the home’s original value, you can request cancellation in writing, subject to conditions such as a good payment history. Each premium you stop paying adds to what the prepayment earns, on top of the mortgage rate. FHA and VA loans follow different rules.
• Safe alternatives. If an insured savings account or CD pays more than your mortgage rate after tax, prepaying loses even without market risk.
• Access. The investment account can be sold, at whatever it is worth that day. The prepaid $42,974.79 is home equity.

Should an emergency fund or higher-rate debt come first?

Each has a strong case: an emergency fund because money sent to principal is hard to get back, and higher-rate debt because paying it off earns more than 6.875%. Your required payment doesn’t change, so after a job loss, ten years of $250 extra payments ($30,000 of your cash) doesn’t cover a single month; reaching it means selling the home or applying to borrow against it. An emergency fund is meant to be cash you can reach quickly, which home equity is not.

The fund and the extra payments compete for the same dollars. Say your essential expenses are $5,000 a month and you choose three months of coverage (the right number depends on your situation): the target is $15,000. With $8,000 saved, the $7,000 gap takes 28 months at $250 a month, more than two years in which that $250 isn’t going to the mortgage. Splitting it is an option; the first table shows what $100 a month does.

Higher-rate debt belongs in the same comparison. Paying down a credit card that charges, for example, 22% APR earns 22% on every dollar, more than three times the mortgage rate here. Investor.gov makes the same point: clearing high-interest debt outperforms virtually any investment, with less risk. The debt snowball vs. avalanche calculator orders several debts.

An employer retirement match you aren’t collecting belongs in the comparison too. A 401(k) plan that adds 50 cents for each dollar you contribute turns that dollar into $1.50 at once, before any growth, although a vesting schedule can delay when the match is fully yours. The employer match calculator shows what you need to contribute to collect the full match.

Can your lender charge a prepayment penalty?

Only if your loan has one, and you would have agreed to it at closing. Penalties usually apply to paying off the whole loan (selling or refinancing) within the first few years, and sometimes to a large lump sum. The CFPB says they don’t normally apply to small extra principal payments, but check with your lender. The Loan Terms table on your Loan Estimate and Closing Disclosure has a “Prepayment Penalty” line that answers the question for your loan.

For most home-purchase and refinance mortgages, Regulation Z allows a penalty only on a fixed-rate qualified mortgage that isn’t a higher-priced loan. It can’t exceed 2% of the amount prepaid in the first two years or 1% in the third, can’t apply after three years, and the lender must have offered you a loan without one. Under that cap, a $25,000 lump sum in year two could cost at most $500. Loans outside the rule can have other terms, so your note is the final word; the uniform fixed-rate note, for one, allows full or partial prepayment with no charge.

How do you make sure extra money goes to principal?

Label the payment, be current, and check the statement. The uniform fixed-rate note gives you the right to prepay principal at any time and sets out how prepayments work:

• Say so in writing. The note has you tell the lender in writing that a payment is a prepayment, so use your servicer’s principal-only option or write “apply to principal” with the payment.
• Be current first. A payment can’t be designated as a prepayment while regular monthly payments are past due.
• Interest can come first. The lender may apply part of a prepayment to interest accrued on the prepaid amount before reducing principal.

Then check your next statement: the principal balance should fall by the regular principal plus your extra amount, less any interest applied first.

What the example leaves out

• Adjustable rates. The example assumes a fixed rate; after a rate reset every figure changes.
• Servicer timing. The schedule applies each extra payment on its due date and charges interest monthly, so your statements may differ by small amounts.
• Inflation. A dollar of interest saved in year 25 is worth less than a dollar today, one more reason the rate comparison is a better yardstick than the lifetime total. See nominal vs. inflation-adjusted returns.

This is an educational estimate, not financial, tax or legal advice.

Try it

Mortgage extra payment calculator: enter a current balance of 320,000, an interest rate of 6.875 and a time left of 28 years, and leave the monthly P&I blank so the page uses the computed $2,148.47. Try one kind of extra at a time:

• Extra monthly 250 saves $114,998.35 of interest and repays the loan in 254 payments (21 years 2 months).
• Clear the extra monthly and enter an extra yearly of 2,148.47 with yearly month 12: 274 payments and $86,885.69 saved.
• Clear the extra yearly and enter a one-time extra of 10,000 in month 61: 315 payments and $35,398.73 saved.
• For the recast table, clear the one-time extra and change the balance to 295,000. The computed payment is $1,980.62, with $370,488.19 of interest. Then clear the time left and enter a monthly P&I of 2,148.47: the loan is repaid in 271 payments with $285,984.52 of interest.

Compound interest calculator: initial deposit 0, regular contribution 250 monthly, contribution timing End of period, annual interest rate 6.875, compounding Monthly and 10 years. The balance is $42,974.82. Change the rate to 4 or 9 for the other rows: $36,812.45 and $48,378.57.

Emergency fund calculator: choose One monthly total, then enter monthly essential expenses of 5,000, 3 months of coverage, current emergency savings of 8,000 and 250 a month that you can set aside. The target is $15,000.00, with $7,000.00 still to save, reached in 28 months.