As you get closer to paying off debts like a mortgage, car loan or credit card balance, it gets more and more tempting to pay the entire amount at once rather than to keep sending a monthly check. However, because of extra charges, the payoff on your loan isn't always the same thing as your outstanding balance.
The balance remaining on your loan equals the unpaid principal plus any unpaid interest. Each month, a portion of your loan payments goes to paying down the interest that accrued on the loan and the remaining goes toward paying down the principal. For example, if $200 of interest accrued on your loan during the prior month and you make a $340 monthly payment, the first $200 goes to interest and then your balance is reduced by $140.
Additional Accrued Interest
When you receive your monthly statement from your lender, it doesn't include the interest that's accrued since your last payment. For example, if it takes five days for your statement to get to you after you've made your payment, that's five more days worth of interest that you owe on the outstanding balance.
Loans often include additional charges for paying it off too quickly. The incentive for the lender is financial -- the longer you keep the loan out, the more interest you pay them. Sometimes the charges are obvious, and the loan clearly states that if you pay off the debt before a certain amount of time has passed you owe an extra amount. However, sometimes it's not as clear. For example, some loans come a condition that applies all your payments to the precomputed interest before it ever touches the principal. So, no matter how early you pay the loan, you're still stuck paying the same amount that you would if you spread it out over the entire repayment term.
Figuring Necessary Payoff Amount
If you're thinking about paying off your loan, contact your lender before you make the payment so you know exactly how much you have to pay on the payoff date to completely wipe out the debt. According to the U.S. Consumer Finance Protection Bureau, your lender must provide you a payoff amount for your requested date on a closed-end mortgage on your main home. Even if your lender isn't legally obligated to provide a payoff amount, many will do so upon request.
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