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How Extra Principal Payments Can Save You Money on Loans

Understanding Principal-Only Payments: A Comprehensive Guide

When it comes to managing loans, understanding the intricacies of principal-only payments can be a game-changer. At O1ne Mortgage, we believe in empowering our clients with the knowledge they need to make informed financial decisions. If you have any questions or need assistance with your mortgage, don’t hesitate to call us at 213-732-3074. Let’s dive into the world of principal-only payments and explore their benefits and drawbacks.

What Is a Principal-Only Payment?

A principal-only payment is an additional payment made towards the principal balance of a loan. The principal is the original amount borrowed, which accrues interest over time. By making principal-only payments, you can reduce the principal balance faster, thereby decreasing the amount of interest that accrues over the life of the loan.

For instance, consider a $400,000 mortgage with a 6% interest rate and monthly payments of $2,398.20. If you decide to make an extra $200 monthly principal-only payment for three years, the portion of each payment that goes towards interest will decrease more rapidly.

No Extra Payments vs. Extra Payments

Let’s compare the impact of making no extra payments versus making extra principal-only payments:

  • No Extra Payments:
    • First Payment: $398 (Principal) / $2,000 (Interest)
    • 12th Payment: $421 (Principal) / $1,978 (Interest)
    • 24th Payment: $447 (Principal) / $1,952 (Interest)
    • 36th Payment: $474 (Principal) / $1,924 (Interest)
  • Extra $200 Monthly Principal-Only Payments:
    • First Payment: $598 (Principal) / $2,000 (Interest)
    • 12th Payment: $632 (Principal) / $1,967 (Interest)
    • 24th Payment: $671 (Principal) / $1,927 (Interest)
    • 36th Payment: $712 (Principal) / $1,886 (Interest)

Over three years, the total interest savings amount to $1,220, and the difference in the remaining mortgage balance is $10,820. This demonstrates how making extra payments and paying less interest can quickly add up.

Pros and Cons of Principal-Only Payments

Before deciding to make principal-only payments, it’s essential to weigh the pros and cons.

Pros

  • Pay Less Interest Overall: Reducing the principal balance results in less interest accruing over the loan’s lifetime, saving you money.
  • Pay Off the Loan Sooner: By paying down the principal, you can potentially pay off the loan early.
  • Flexible Payment Amounts: You can make principal-only payments whenever you feel comfortable, without committing to an additional amount each month.

Cons

  • Monthly Payments Remain the Same: Your required monthly payment generally stays the same, even if you make a large principal-only payment.
  • Decreases Available Cash: Making extra payments reduces the cash you have on hand for other debts or opportunities.
  • Potential Lack of Benefits: Some loans have precomputed interest, so paying down the principal may not save you money. Additionally, some loans have prepayment penalties.

Is It Better to Pay Principal or Interest?

Typically, lenders apply your standard payments to the interest and fees that have accrued since your last payment, with any remaining funds going towards the principal. While you often don’t have a choice in this matter, paying off the principal is the ultimate goal. If you’re making extra payments, inform your lender that you want the money to go towards the principal balance.

If you’ve significantly paid down your loan balance, you might be able to recast your loan. Recasting allows you to keep the same repayment schedule and term but adjusts your monthly payment based on your current balance. Although lenders may charge a fee for recasting, it can help lower your monthly payment and is generally a quick and easy process. Unlike refinancing, recasting doesn’t require applying for a new loan, as your current lender simply changes the loan’s terms.

Should You Pay Off Your Mortgage Early?

Deciding whether to pay off your mortgage early depends on your financial situation and goals. While making extra principal-only payments can save you money on interest and help you pay off your loan sooner, it’s essential to consider other factors such as your available cash, other debts, and investment opportunities.

At O1ne Mortgage, we’re here to help you navigate these decisions. Our team of experts can provide personalized advice and support to ensure you make the best choices for your financial future. Call us today at 213-732-3074 to discuss your mortgage needs and explore your options.

Improve Your Credit While Paying Off Loans

Making extra principal-only payments won’t necessarily have a significant impact on your credit scores. However, consistently making on-time loan payments and paying down balances can improve your credit over time. You can track your progress by obtaining your FICO® Score and credit report for free from Experian. As your credit improves, you may also qualify for better credit card and loan offers.

In conclusion, principal-only payments can be a valuable strategy for managing your loans and saving money on interest. By understanding the benefits and drawbacks, you can make informed decisions that align with your financial goals. At O1ne Mortgage, we’re committed to helping you achieve financial success. Contact us at 213-732-3074 for expert guidance and support with your mortgage needs.

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