Most couples purchase their first home with the help of a mortgage, which is a loan secured by the value of the house. A mortgage typically lasts for either 15 or 30 years. However, if you sit down and calculate how much you're actually paying out over the length of the loan, factoring in the interest to your lender, you may not like the number you see. Some couples decide to pay their mortgages down more quickly using a strategy known as principal curtailment.
TL;DR (Too Long; Didn't Read)
Principal curtailment involves making extra mortgage payments so that you reduce your total interest costs and pay off your mortgage balance sooner.
Defining Principal Curtailment
Principal curtailment is a complicated way of saying principal reduction. It involves making extra payments on your mortgage to reduce the balance of the loan faster. Because these payments lower the principal balance at a faster rate than originally determined, you end up paying less total interest over the life of the loan. You also shorten the term of the loan.
Exploring Some Examples
To employ principal curtailment, you can either make one or more irregular lump sum payments toward your loan, or you can make extra fixed payments each month or year. For example, you may decide to pay $100 extra toward your mortgage each month, make lump sum payments of $400 or more yearly, or make a one-time lump sum payment of $10,000 to reduce the balance of the loan.
Benefits of Principal Curtailment
The figures don't lie. If you owe $100,000 on a 30-year mortgage at 6 percent interest and you make an extra payment of $100 per month, the loan term will decrease by nine years and you will save $39,900.25 in interest payments. If you make a one-time payment of $10,000 during the first year of the loan, the loan term will decrease by six years and nine months, and you will save $38,721.18 in interest.
Things to Consider
Though principal curtailment reduces the total interest paid and the length of the loan term, it doesn't reduce your monthly payment. If you make extra payments on your loan balance and then decide then you'd like to reduce your monthly payment, you can refinance the loan at the lower balance and possibly a lower interest rate, if you can find one.
Of course, you'll have to factor in closing costs on a new loan – and since the loan term will start over after the refinance, the total amount of money you were saving from principal curtailment will decrease. However, you can take the money you're saving each month with your new mortgage and use it for other investments.
Amanda McMullen is a freelancer who has been writing professionally since 2010. She holds a bachelor's degree in mathematics and statistics and a second bachelor's degree in integrated mathematics education.