Is it a good way to principal-only payments? Will it lower the interest rate to help me save money? In most cases, it is a better method, but there are disadvantages. This article will provide a comprehensive overview of the advantages and disadvantages of principal-only payment and how to convert it. Continue reading.
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What is a Principal-Only Payment?
An extra payment made to the principal of your mortgage loan is known as a principal-only payment or an additional principal payment. It goes over the planned monthly amount, possibly saving you money on interest and allowing you to pay off your mortgage sooner.
You might need to let your lender know that you want to use the additional funds to pay down the principal rather than the interest.
How Can Principal-only Payment Help?
In addition to taxes and insurance, two expenses are covered by your mortgage loan payments: the principal and interest. A process known as amortization starts once you start making these payments. You can check the amortization schedule for your mortgage to see how much of your own monthly payment is allocated to principal and interest.
In the initial years, interest consumes the majority of the funds. If you pay off your fixed-rate mortgage early, your interest will change because the interest is calculated based on the principal balance.
Therefore, increasing your principal-only payment lowers the amount of money you’ll pay interest on before it starts to accumulate.
Should You Opt for Principal-Only Payments?
Your financial situation and the capital opportunity cost will determine whether you choose principal-only payments. Extra payments may be justified for you in some circumstances, but not always.
Yes, if your debt interest is high.
The opportunity cost of allocating capital to repay the loan is low if the debt interest is high. This is due to the fact that it is unlikely that you will be able to generate higher returns somewhere else, so it makes sense to get rid of the liability first.
No, if you have other high-interest loans.
If you already have an outstanding high-interest loan, choosing principal-only payments on a low-interest loan is not a good idea. Any additional funds should be used to pay off the more expensive loan first.
Yes, if you can avoid prepayment penalties
When you agree to repay loans early, lenders don’t like it because they want to make as much money as possible. It prevents them from receiving future interest payments.
Prepayment penalties, or additional fees, are imposed by some lenders when loans are repaid early. These, however, differ greatly depending on the lender and loan type. Prior to making any additional payments, you should confirm the terms.
No, if it means going hungry.
Skip it if it means you won’t have the things you need to live or won’t be able to pay your bills.
Pros and Cons of Additional Principal-Only Payments
Now that you know the basics, consider the following benefits and drawbacks of making additional principal-only payments:
Pros
- Save on interest: By making monthly overpayments in excess of what they owe, borrowers can reduce their interest costs.
- Shorten your loan term: By reducing your balance, you can shorten the length of your loan and pay off your mortgage sooner.
- Pay down other debt: It provides you with the chance to concentrate on other debts, like credit card debt, student loans, or auto loans, and advance your financial situation.
- Promising financial future: Once your mortgage is fully paid off, you can use the extra cash you saved by paying it off earlier.
Cons
- Potential fees: For making extra payments each month, some banks might impose a fee (or fees). We don’t.
- Prepayment penalties: Your lender may charge you a prepayment penalty if you repay your loan early. No prepayment penalties apply with Rocket Mortgage.
- Fewer funds: Making extra payments means you can’t use that money for other things, like investing or creating an emergency fund.
How to Make a Principal-Only Payment?
Sadly, not all lenders accept additional loan payments without levying a fee. Furthermore, even though some lenders permit you to make additional payments without incurring fees, if you don’t specifically state that you want to make principal-only payments, you might still see a portion of the payment go toward interest.
Check your lender’s repayment guidelines first if you wish to make an additional principal-only payment. For principal-only payments (if they’re permitted), each lender has a unique procedure. It’s possible that you’ll have to pay your extra amount along with your regular one. In some cases, you might need to get an extra payment slip and check a box that says, “principal-only.”
Automate Your Payments
The ideal way to make payments is to automate them whenever you can. Some lenders permit you to add an additional automatic payment each month, with the condition that all additional payments must be applied to the principal.
You can manage your debt without having to manually and regularly make an extra payment each month if you can set this up online or over the phone.
Watch Out for Prepayment Penalties
You should be aware that some lenders won’t accept principal-only payments. However, they won’t go exclusively toward the principal. You can make additional payments every month. Making the extra payment in these circumstances will still help you pay off your debt faster, so it is still advantageous.
However, there are some lenders who not only forbid principal-only payments but also impose prepayment fees. Therefore, if you pay off your loan early, you might incur additional fees. These creditors attempt to offset some of the lost interest from your accelerated payments by charging you a fee.
Do the math before you start making additional payments. Determine whether there is a prepayment penalty and, if there is, whether the amount of interest you will save will be sufficient to make up for it.
Consider Refinancing With a New Lender
If you still have a sizable balance to pay off ($5,000 or more), and your current lender will charge you a prepayment penalty each time you want to make an extra payment, look around to see if you can find a lender with better terms.
Paying your current lender a one-time fee to refinance/consolidate your debt(s) with the new lender and avoid repeat prepayment fees may be worthwhile if you find a new lender with a competitive interest rate and flexible repayment terms.
Do Large Principal-Only Payments Reduce Monthly Payments?
Unless you refinance your mortgage, your monthly payment will stay the same regardless of how many principal-only payments you make on your loan. You will automatically save more money on interest over the course of the loan if you do nothing more than make additional payments against the principal, which will result in fewer monthly payments of the same amount.
To that end, you might want to think about recasting your mortgage if you’re trying to trade your end-of-year bonus for lower monthly payments. In order to qualify, you would typically need to pay a minimum lump sum of $5,000 (check the details of your loan terms) as well as a small servicing fee. In exchange for a lower monthly payment, the lender would amortize your new principal amount over the remaining period of your loan term at the same interest rate.
How To Alternatives Principal-Only Payments?
Making additional principal-only payments is not the only option. Consider the following:
Biweekly Mortgage Payments
A borrower may receive an additional full monthly payment each year by setting up biweekly mortgage payments. By doing this, you can reduce the amount of interest that accumulates and cut years off the length of your loan.
Refinancing
Refinance a mortgage with a longer term, such as a 30-year fixed-rate loan, into one with a shorter term, like a 15-year loan. Additionally, it might enable you to pay off your debt faster. Your lender may lower your interest rate as a result.
In this article, you have found out the pros and cons of principal-only payment, and how to choose it in different conditions. You also can transfer to principal-only payment if you think it is good for you. Do you grasp principal-only payment?
FAQs About Principal-Only Payment
Are There States That Don’t Allow Principal-only Payments?
All states permit principal-only mortgage payments, but not all lenders will accept them. If you are able to make additional principal payments, speak with your lender. These are allowed by Rocket Mortgage.
Is It Better to Pay the Principal Or Interest on a Mortgage?
As mentioned above, you can lower your overall interest costs by making additional principal payments. Making more principal-only payments will also help you to build equity more quickly because every payment made toward your principal increases your home’s value.
Do Principal-only Payments Lower Monthly Payments?
Principal-only payments alone won’t reduce your monthly payments, as was already mentioned. You will need to refinance or recast your mortgage in order to achieve this, or you can try other methods of reducing your mortgage payment.
