Last updated: 2026-05-19

Loan prepayment

Loan prepayment is the practice of paying more than the scheduled amount toward a loan's principal, ahead of the contractual repayment schedule. On a fully amortizing fixed-rate loan, a recurring extra payment shortens the term and reduces the total interest paid, because interest accrues only on the outstanding balance.

How extra principal reduces interest

On a standard fixed-rate loan, every monthly payment is split between interest and principal. In the early years, most of the payment is interest, and only a small portion reduces the balance. On a $300,000 30-year mortgage at 6%, the first payment of $1,798.65 includes $1,500 of interest and $298.65 of principal reduction.

This front-loading follows directly from how interest accrues: interest is charged on the outstanding balance each month, so when the balance is large, the interest charge is large. Each extra dollar of principal retires a dollar of balance permanently, eliminating the future interest that dollar would have generated across every remaining month of the loan.

For this reason, a $200/month extra payment on that same $300,000 mortgage at 6% saves roughly $89,000 in interest and cuts the payoff time by about 81 months (6.75 years). The $200 does not save only $200 — it saves $200 multiplied by the number of months it would otherwise have generated interest, minus the principal amortization that would have occurred anyway.

Formula

The original monthly payment (PMT) uses the standard amortization formula:

$PMT = \frac{L \cdot i \cdot (1+i)^n}{(1+i)^n - 1}$

where $L$ is the loan principal, $i = r/12$ is the monthly interest rate (annual rate divided by 12), and $n$ is the original term in months.

With an extra monthly payment $E$, the effective payment becomes $PMT_e = PMT + E$. The new payoff term is the closed-form solution for when the loan balance reaches zero:

$n_{new} = \left\lceil \frac{\log\left(\frac{PMT_e}{PMT_e - L \cdot i}\right)}{\log(1+i)} \right\rceil$

The ceiling (rounding up to the next whole month) reflects a partial final payment in the last month; the interest-saved calculation accounts for this.

Total interest under each schedule is total payments minus principal:

$\text{Interest} = PMT \times n - L \qquad \text{and} \qquad \text{Interest}_{new} = PMT_e \times n_{new} - L$

Interest saved is the difference between the two.

Worked example: $325,000 mortgage at 6.5%, 30 years

A homebuyer in 2024 takes out a $325,000 mortgage at 6.5% for 30 years.

• Monthly payment (PMT): $2,054.22
• Total interest (30 years): $414,520

Now suppose they pay an extra $150/month:

• Effective payment: $2,204.22
• New payoff term: 297 months (24.75 years)
• Total interest (accelerated): approximately $329,700
• Interest saved: approximately $84,900
• Months saved: 63 months (5.25 years)

For $150/month in extra payments — a total out-of-pocket increase of about $44,600 over the accelerated term — the borrower avoids roughly $84,900 in interest: less than $45,000 in extra cash offsets nearly $85,000 in interest. The effect arises because each extra dollar retires principal early, and every retired principal dollar would otherwise have generated interest across all remaining months.

Timing of extra payments

The front-loading effect means the same dollar saves more interest when applied early in the loan term than late. An extra payment in month 1 removes that principal for all 360 remaining months; the same payment in month 300 removes it for only 60 months.

This calculator assumes extra payments begin immediately. For a loan already partway through its term, the savings can be estimated by entering the current outstanding balance as the principal and the remaining term as the loan term — the savings will be smaller than for a fresh loan, but still meaningful.

Edge cases and variations

• Variable-rate loans. The formula assumes a fixed rate for the entire accelerated term. On an adjustable-rate mortgage (ARM), the rate — and therefore the savings — changes at each adjustment.
• Lump-sum paydowns. The calculator assumes a constant monthly extra payment. A one-time lump sum reduces principal immediately and saves all future interest on that amount; it can be approximated by treating the post-paydown balance as a new loan.
• Biweekly payment programs. Some lenders offer biweekly payment programs that effectively add one extra full payment per year. Entering one-twelfth of one monthly payment as the extra monthly payment approximates this.
• Opportunity cost. The interest-saved figure does not compare prepayment against investing the same cash. The Compound Interest Calculator can model what the same monthly amount would grow to in a market account.
• Tax deductibility. US homeowners who itemize deductions can deduct mortgage interest, which reduces the effective cost of the interest and therefore reduces, but does not eliminate, the prepayment advantage. The after-tax rate gives a more accurate comparison.

Application: choosing an extra payment amount

There is no universal answer. A common sequence of priorities is:

1. Emergency fund first. Three to six months of expenses, held liquid. Prepaying a mortgage is illiquid, since home equity cannot be withdrawn easily in an emergency.

2. Employer 401(k) match. A typical match is a guaranteed 50–100% return, which exceeds even a 10% mortgage prepayment return.

3. High-rate debt first. Credit-card debt at 18–25% annual percentage rate (APR) is generally worth eliminating before prepaying a 6% mortgage.

4. Prepayment versus investing. At a 4% mortgage rate against an expected 8% long-run equity return, investing tends to win on expectation. At a 7% mortgage rate, prepayment wins on certainty for a risk-averse borrower. Many financial planners suggest splitting extra cash between prepayment and tax-advantaged accounts once the prior priorities are met.

5. Prepayment penalties. Most modern US mortgages (conventional and FHA in particular) have no prepayment penalty. Some older loans and some personal-loan products do; this is worth verifying before prepaying aggressively.