Extra Payments on Your Loan: How They Save You Money

What are extra payments and how do they work?

An extra payment is any amount you pay toward your loan beyond your scheduled monthly payment. When you make an extra payment, the lender typically applies it to your principal balance—the original amount you borrowed—rather than to future interest. Because interest is calculated on the outstanding principal, reducing that balance reduces the total interest you’ll pay over the life of the loan.

Extra payments can be made in different ways: as a one-time lump sum, as an additional amount added to your regular monthly payment, or as part of a biweekly payment schedule. The key is to ensure the extra amount is applied to the principal, not to the next month’s payment or to escrow for taxes and insurance.

• Extra payments reduce the principal balance, which in turn reduces the amount of interest charged over the loan’s life.
• They can shorten the total loan term, allowing you to become debt-free sooner.
• Even small, regular extra payments can have a noticeable impact on interest and term.

Sources: Fannie Mae, Total Mortgage

Impact on total interest and loan term

The impact of extra payments is most significant in the early years of a loan because interest is front-loaded. In a typical amortizing loan, the largest portion of your early payments goes toward interest. By making extra principal payments early, you eliminate that principal balance, so it no longer accrues interest for the remaining term. This means the total interest saved is greater when extra payments are made sooner.

Biweekly payments—where you make half your monthly payment every two weeks—are equivalent to making 13 full payments per year instead of 12. This extra payment per year can also reduce your term and interest, often by several years and tens of thousands of dollars.

Sources: Fannie Mae, Total Mortgage, Bankrate

Example: $100 extra payment on a $20,000 loan

This illustrates how even a modest regular extra payment can accelerate your payoff and reduce total interest. The exact numbers would vary with your loan's interest rate and term, but the principle holds.

Sources: Fannie Mae

Ways to make extra payments: biweekly, lump sum, rounding up

There are several practical strategies to make extra payments. The best approach depends on your cash flow and financial goals.

Biweekly payments: Instead of making one monthly payment, you pay half your monthly payment every two weeks. Over a year, you make 26 half-payments, which equals 13 full monthly payments—one extra payment per year. This method automates the extra payment and can significantly reduce your term and interest.

Rounding up: Another simple strategy is to round up your monthly payment to the nearest hundred or any amount you choose. This is a flexible way to make extra payments without a large commitment, and it can also reduce interest and shorten the term over time.

Sources: Total Mortgage, PrimeLending

Considerations: prepayment penalties, lender policies

Before you start making extra payments, check with your lender about their policies. Some loans may have prepayment penalties—a fee for paying off your loan early. While such penalties are relatively rare for mortgages, they can exist, especially for certain loan types or within the first few years.

Also, you must specify that the extra payment be applied to the principal. If you don’t, the lender might treat it as early payment of your next month’s regular payment, which would not reduce your principal balance or interest savings. Always include a note or use the lender’s online portal to direct the extra amount to the principal.

Finally, consider your overall financial situation. If you have high-interest debt, such as credit card balances, it may make more sense to pay that down first, because the interest savings from that debt outweigh the savings from your lower-rate loan. Also, extra payments reduce your liquidity, since the money is tied up in a non-liquid asset until you sell or refinance.

Sources: American Financing, Total Mortgage

When extra payments make sense vs. investing

Deciding whether to make extra payments on your loan or invest that money elsewhere depends on the interest rate on your loan and the potential return on your investments. If your loan’s interest rate is higher than what you could realistically earn on an investment, paying down the loan is likely a better financial move because the guaranteed savings from reduced interest exceed the uncertain investment returns.

However, investment returns are not guaranteed, and the interest on your loan is a certain cost. The peace of mind from being debt-free and the guaranteed interest savings can be worth more than the potential investment gains.

One common guideline is to prioritize paying off high-interest debt, such as credit card balances, before making extra payments on a lower-rate loan. Beyond that, the decision is personal and depends on your risk tolerance, cash flow, and long-term goals.

If you have a stable income and an emergency fund, making extra payments can be a safe, low-risk way to build equity and reduce debt. But if you might need liquid cash in the near future, investing in liquid assets might be more appropriate, because extra payments reduce your access to that money.

Sources: Bankrate