Loan amortization and extra payments – Wells Fargo (2024)

FAQs

Should you make additional payments on amortized loans? ›

Making your normal monthly payments will pay down, or amortize, your loan. However, if it fits within your budget, paying extra toward your principal can be a great way to lessen the time it takes to repay your loans and the amount of interest you'll pay.

When you pay more than the total amount due, on or before the due date, the additional amount will pay down your principal balance and will be applied to your next payment due. You can pay your account up to 3 months in advance. Once the account is paid ahead 3 months, additional funds go toward principal only.

An amortizing loan has fixed, periodic payments that are applied to both the principal and interest until the loan is paid in full. At the beginning of your repayment period, more—if not most—of your payment covers the cost of interest.

Extra payments toward your loan's principal (or the amount of the loan) can reduce the total amount you repay by reducing the total interest you pay. When you make extra payments, you can also reduce the loan's terms and pay your debt down faster. It can also lower the amount of your future monthly payments.

What happens if I pay an extra $200 a month on my mortgage? You'll pay your loan off ahead of schedule. It's impossible to say how far ahead because we don't know your loan balance, payment, or interest rate. If you have a $300,000 balance, a rate of 4.5% and a payment of $1,601, you'll pay off your loan in 27 years.

Since your interest is calculated on your remaining loan balance, making additional principal payments every month will significantly reduce your interest payments over the life of the loan. By paying more principal each month, you incrementally lower the principal balance and interest charged on it.

The key is to specify to your lender that you want your extra payments to be applied to your principal. If you don't make this clear, you may find the extra payment going toward the interest you owe rather than the principal.

Throwing in an extra $500 or $1,000 every month won't necessarily help you pay off your mortgage more quickly. Unless you specify that the additional money you're paying is meant to be applied to your principal balance, the lender may use it to pay down interest for the next scheduled payment.

How to calculate loan amortization. You'll need to divide your annual interest rate by 12. For example, if your annual interest rate is 3%, then your monthly interest rate will be 0.25% (0.03 annual interest rate ÷ 12 months). You'll also multiply the number of years in your loan term by 12.

Is amortization good or bad? ›

Longer Amortization Periods Reduce Monthly Payments

Loans with longer amortization periods require smaller monthly payments because you have more time to pay back the loan. This is a good strategy if you want payments that are more manageable.

Starting in month one, take the total amount of the loan and multiply it by the interest rate on the loan. Then for a loan with monthly repayments, divide the result by 12 to get your monthly interest. Subtract the interest from the total monthly payment, and the remaining amount is what goes toward principal.

Disadvantages. You'll quickly spot the main disadvantage when you review the amortization schedule. With fully amortized loans, you pay the bulk of your interest charges upfront. It can take years before the bulk of your mortgage payment goes toward your principal balance.

Over time, as you pay down the principal, you owe less interest each month, because your loan balance is lower. This means that over time, more of your monthly payment goes to paying down the principal.

How extra payments affect your amortization schedule. You do have the option to pay extra toward your mortgage, which will alter your amortization schedule. Paying extra can be a good way to save money in the long run, because the money will go toward your principal, not the interest.

Overall, paying more than the monthly amount due on an amortized loan is a wise strategy as it reduces the total interest paid, shortens the loan term, and helps build equity. It can save you money in the long run and provide financial flexibility.

Disadvantages. You'll quickly spot the main disadvantage when you review the amortization schedule. With fully amortized loans, you pay the bulk of your interest charges upfront. It can take years before the bulk of your mortgage payment goes toward your principal balance.

Making an extra mortgage payment each year could reduce the term of your loan significantly. The most budget-friendly way to do this is to pay 1/12 extra each month. For example, by paying $975 each month on a $900 mortgage payment, you'll have paid the equivalent of an extra payment by the end of the year.

Borrowers use an accelerated amortization strategy to save money on interest and pay off their mortgage faster. Accelerated amortization does have drawbacks: It can deprive the borrower of a tax deduction, and some lenders charge prepayment penalties.