Paying down a loan gives any borrower a feeling of accomplishment. If you’ve whittled your loan down to an amount that’s within reach of your being able to satisfy the entire debt, you may notice a discrepancy between the loan’s payoff amount and the current balance. Instead of dismissing this as a typo, it may help to know that the difference is likely correct because of the way the interest portion of your loan is calculated.
TL;DR (Too Long; Didn't Read)
Wells Fargo describes the difference between payoff and balance on a loan as the amount you currently owe (balance) compared to the amount it would cost you to pay off your loan by a specific date (total payoff).
What Is Your Current Balance?
When you look at the current balance on your loan statement, this amount represents the unpaid principal of the loan plus the unpaid interest on the date of the statement. In the case of a mortgage, for example, the amortization schedule typically includes interest as the bigger portion of your total payment in the early years of the loan.
As you continue to make payments, the gap between interest and principal narrows, until you reach the point in your payment schedule when principal and interest each comprise 50 percent of your payment. When you hit this point, the momentum shifts, and you’ll begin making bigger payment portions toward the principal amount and smaller payment portions toward interest as your loan moves toward its maturity date.
What Is Your Payoff Amount?
Your loan’s payoff amount essentially is your unpaid balance plus the interest that accrues from your statement date and your intended payoff date. Your lender will calculate the per diem interest for this time frame and add it to your unpaid loan balance. And if your loan carries any fees for early payoff, this amount is also included in your payoff amount. It's this continual shifting of your loan's designated portion of interest payments that influences why your current balance and payoff amount are not the same – this is why your payoff amount is higher than your statement balance.
Instead of making a best-guess stab at your exact payoff amount vs. your balance, contact your lender. This will save you time rather than attempting to perform the calculation yourself. Some lenders may give you a payoff quote over the phone, others will send you a quote from their website or email, and a few may require you to submit a written request for this information. As a heads-up, however, if you pay off your loan even one day after your requested payoff date, your payment will not be accurate because another day’s interest will have accrued.
Prepayment Penalty Fees
If your loan includes a prepayment penalty fee, your lender had to disclose this on the truth-in-lending statement in your loan agreement. Many lenders impose this penalty to protect themselves against the interest income they would lose if a borrower pays off a loan earlier than its original maturity date. A prepayment penalty is usually calculated based on a percentage of the remaining loan balance.
Some prepayment penalties only kick in during a certain time frame, within the first five years of a mortgage, for example. If you're outside this window, you'll be able to avoid the fee.
But you may also have a prepayment penalty if you pay a substantial portion of your loan balance in one fell swoop – even without paying off the loan entirely. So be sure to read the fine print or talk to your lender before making a large payment that's in addition to your regular, periodic payment.
Victoria Lee Blackstone was formerly with Freddie Mac’s mortgage acquisition department, where she funded multi-million-dollar loan pools for primary lending institutions, worked on a mortgage fraud task force and wrote the convertible ARM section of the company’s policies and procedures manual. Currently, Blackstone is a professional writer with expertise in the fields of mortgage, finance, budgeting and tax. She is the author of more than 2,000 published works for newspapers, magazines, online publications and individual clients.