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If you spend any time around homeowners, you’ll probably hear at least one of them talk about making an extra mortgage (or principal) payment to pay off their mortgage faster. This process is sometimes called mortgage curtailment or a principal reduction (although most people don’t use that term in casual conversation).
It’s a common strategy, but does it work?
In short, yes: curtailment works. However, the amount you save will depend on the amount and frequency of your extra payments. The terms of your mortgage loan will also outline whether you can curtail your mortgage. And if so, by how much.
Let’s explore whether mortgage curtailment is the right financial move for you.
What Is Curtailment on a Mortgage Payment?
According to Merriam-Webster, to curtail is to reduce by “cutting off or away some part.” When it applies to a mortgage, curtailment (also known as principal curtailment) refers to making extra payments in addition to your scheduled payments to reduce your mortgage balance.
The principal on the loan (the total amount you borrowed) drops every time you make a payment.
Homeowners make mortgage curtailment payments to pay down mortgage principal faster and save money on interest.
How Does a Mortgage Curtailment Work?
When you make a scheduled mortgage payment, the money is split between the loan’s interest and principal. At the start of mortgage repayment, interest accrues on the full – or almost full – balance of the loan. Most of your monthly mortgage payment goes toward interest.
As you pay down the principal, less interest accrues and more of the monthly payment goes toward the principal.
Mortgage curtailment speeds this process up. Once you’ve paid your scheduled monthly mortgage payment, you can apply additional money to the principal.
How does this benefit you? Well, principal curtailment reduces the balance of the loan. The less principal you owe, the less interest you’ll pay.
With the right curtailment strategy, you could save tens of thousands of dollars over the life of your loan, and you’ll own your home outright in less time.
Let’s say you take out a 30-year mortgage for $200,000 with a 4.5% interest rate. If you pay an extra $100 per month, you’ll save more than $29,000 in interest payments. Plus, you’ll pay off the mortgage 6 years and 4 months earlier than you would if you only made your regularly scheduled payments.
Before you start throwing all your disposable income at your mortgage, read the fine print on your mortgage agreement. Lenders earn money from the interest on loans, so they may set limits on additional payments.
It’s also important to balance curtailment with your immediate and future cash flow needs. Make sure you have enough money to cover emergencies, unexpected expenses and all your bills. If you can’t meet your other expenses without taking on high-interest debt, that could cancel out the savings you earn on mortgage interest.
How Are Curtailment Payments Applied?
How your curtailment payments are applied will depend on your lender and the terms of your mortgage. Many lenders will accept extra payments on top of your scheduled monthly payments. But not all lenders accept principal-only payments. If they don’t, part of the extra payment will likely go toward interest and fees.
Before your first curtailment payment, call your lender to check their policy. Some lenders accept funds online or over the phone, while others require you to send in the extra payment along with your scheduled monthly payment.
Also, extra payments don’t typically reduce your scheduled loan payment unless you recast the loan (more about that shortly).
Your lender can also curtail your mortgage. This typically happens when a lender has made an error with the amortization calculations. (Yes, it happens.)
What Are the Different Types of Curtailment Payments?
If you’re interested in paying down your mortgage faster, you can choose between two types of curtailment payments: partial and full. Which option you choose will depend on your financial situation and the terms of your mortgage loan.
We know that extra payments can save money on interest, but how much do you have to pay to make a difference? As it turns out, not much.
A partial curtailment payment pays off part of your loan balance – and it’s usually a very small part. This is the most popular curtailment option, largely because of its flexibility.
Can’t afford an extra payment every month? No problem. You can make an occasional extra payment or a lump-sum payment whenever your finances allow. As long as you stay within the lender’s limits, your payments can be in any amount.
Remember our 30-year mortgage for $200,000 with a 4.5% interest rate? We calculated that paying $100 extra per month could save you more than $29,000 in interest payments and shave 76 months off the loan’s life span. Even if you can only afford $50 per month, you’d still save more than $17,000 in interest and shorten the loan’s term by 43 months.
With a full curtailment, you pay off the entire mortgage all at once. You might consider this option if you come into a large amount of money from a bonus, inheritance or investment.
Lenders don’t always allow early payoffs, but if your lender permits it, you can wipe out your mortgage balance and years of interest payments.
Let’s say you decide to stick to the payment schedule outlined in your amortization schedule for the 30-year mortgage for $200,000 at a 4.5% interest rate. If you never make a curtailment payment, you can expect to pay $164,813.42 in interest over the life of the loan. After your first year of payments, you will have paid $3,226.45 toward the principal and $8,933.99 toward interest, leaving you with a balance of $196,773.55.
If you had enough money to pay off your balance after the first year, you’d save $161,586.97 in interest payments.
Another option that lies between partial curtailment and full curtailment is mortgage recasting. When you recast a mortgage, you make a large lump-sum payment (usually $5,000 or more) toward the balance, and the lender adjusts the loan’s amortization schedule, reducing your monthly payments. Some lenders may require a small fee to recast a mortgage.
If you refinance your mortgage, you could potentially lower your interest rate, but you’ll need to pay closing costs. Recasting can be a strong alternative to refinancing if interest rates have risen. If interest rates have dropped, refinancing can lead to bigger long-term savings.
How Does Curtailment Affect Mortgage Payments?
How curtailment affects your monthly mortgage payment may depend on whether you have a fixed-rate or adjustable-rate mortgage (ARM). To calculate curtailment, subtract the extra payment from the principal balance. The lender will charge interest on the remaining balance.
Your lender may also offer a mortgage calculator to help you understand how regular curtailment payments will impact your loan in the long term.
With a fixed-rate loan, your monthly mortgage payment stays the same over the life of the loan. Curtailment won’t change the amount you pay each month. You’ll pay the same amount every month, but you’ll pay the balance off faster, shortening the loan term and paying less in interest.
Adjustable-rate mortgage (ARM)
Curtailment can still be a smart strategy even if you have an ARM. An ARM usually offers a fixed, lower introductory rate for the first 3 – 10 years of the mortgage. After that, the rate can increase (or decrease) every 6 months or 1 – 5 years depending on market interest rates and the terms of the loan.
By paying down your principal balance more aggressively early on, interest will be charged on a lower balance. That would be especially helpful if interest rates increased at the end of the introductory period.
It’s Like Cutting Your Loan Short
If you’re like many borrowers, you’ll take out a mortgage based on what you can afford at the time. As your salary increases, curtailment is a convenient way to shorten the life of your loan and save thousands on interest.
And if your finances stay the same, you can always stick to your scheduled payments.
As you consider curtailment, it’s important to read the terms of your mortgage loan and keep an eye on your finances and financial goals.