Does Paying Mortgage Early Lower the Interest?
- The monthly interest rate for a home mortgage is the annual interest rate dividend by 12. The monthly rate is applied to the loan balance to calculate the interest portion of the next monthly loan payment. For example, if the interest rate on a mortgage is 6 percent, the monthly rate would be 0.5 percent. If the current loan balance is $100,000, the interest portion of the next monthly payment would be 0.5 percent times $100,000 or $500. The remaining portion of the payment would go to reduce the loan balance.
- The calculation of mortgage payment interest on a monthly basis means the interest and principal amount of a payment are the same no matter when the payment is made on the loan. If the payment is made on the first of the month or the 15th, the interest amount of the payment will remain the same. The amount of the payment going to the principal reduces the loan balance, and the next monthly payment will have a lower interest amount based on the new, lower loan balance.
- Since the interest on the current payment is based on the loan balance, the only way to reduce the interest is to pay down the loan with extra principal payments. If an extra principal amount is added to the mortgage payment, the loan balance used to calculate the interest for the next month's payment will be lower, and the interest portion of the payment will be lower. Adding extra principal to a mortgage payment reduces the interest portion of every future payment.
- There is another type of home loan called a simple interest mortgage, which calculates the interest due on a daily basis. Homeowners with a simple interest mortgage will save on interest if the if the payment is made before the first of the month. If the payment is received by the lender after the first of the month due date, the monthly interest will be higher than on a standard mortgage loan.