How Extra Payments Shorten a Mortgage

Every regular mortgage payment is split. Part covers the interest that has built up since your last payment, and the rest reduces the amount you owe, which is the principal. Early in a mortgage, interest takes a large share. As the balance falls, more of each payment goes to principal.

Why a prepayment works harder than it looks

A prepayment is money you pay on top of your regular payments. Because the interest for the period has already been covered, a prepayment goes straight to principal. From that day on, interest is calculated on a smaller balance, so a little more of every later payment goes to principal too. The effect builds on itself, and it's stronger the earlier in the mortgage it happens.

The result is a mortgage that's paid off sooner and costs less in interest overall. How much sooner depends on the amounts, the timing and your rate.

The usual kinds of prepayment privilege

Most closed mortgages allow some prepayment without a charge. The common forms are:

• Lump sums. An extra amount paid against the principal, up to a yearly limit. Some contracts allow it on any payment date, others only at certain times.
• Increased payments. Raising your regular payment by up to a set limit. The whole increase goes to principal.
• More frequent payments. Moving from monthly to weekly or every other week. An accelerated schedule shortens the mortgage mainly because you end up paying somewhat more over a year than you would monthly.

An open mortgage lets you prepay any amount at any time, usually in exchange for a higher rate.

The limits are in your contract

Privileges differ from lender to lender and from mortgage to mortgage. The limits, the dates on which you can use them, and whether unused room carries forward are all set out in your contract. In many contracts it doesn't carry forward. Going over the limit on a closed mortgage usually triggers a prepayment charge, so it's worth confirming the details with your lender before sending a large amount.

Weighing it against other goals

Extra payments compete with other uses for the same money. Money put into the mortgage isn't easy to get back if you need it later, so many people look first at whether they have savings for emergencies. Debts at higher interest rates, retirement savings and a child's education are other common priorities. There's no single right order. It depends on your rates, your tax situation, your plans and how you feel about carrying debt.

If you'd like to see what your own prepayment privileges allow and how extra payments might change your timeline, we'd be happy to walk through it with you.