Early Mortgage Repayment: When It’s Worth It

How to properly repay your mortgage early, whether it’s better to shorten the loan term or reduce the monthly payment, whether you can save on interest without large savings, and when early repayment is not profitable — we explain all the nuances.

Many borrowers plan to repay their mortgage early even at the stage of signing the loan agreement. But this option isn’t always included in the contract, and if it is, there may be restrictions on timing, payment amounts, and other conditions.

Therefore, along with the main loan parameters — interest rate, term, and monthly payment — check the conditions under which the bank allows early repayment.

Nowadays, banks generally do not prevent early repayment and allow borrowers to pay off the loan even a day after signing. However, it’s still useful to check this clause in your contract.

Annuitized vs. Differentiated Payments: What’s the Difference?

Monthly mortgage payments consist of two parts: the principal (the loan amount) and the interest (the amount the bank charges for using the funds). Depending on the ratio of these parts, payments are either annuitized or differentiated.

• Annuitized payments: The borrower pays equal amounts each month. The ratio of principal to interest changes over time: at the beginning, nearly 80% of the payment is interest and 20% principal. By the end of the loan term, the ratio reverses.
• Differentiated payments: The principal is divided into equal parts throughout the loan term. Interest is charged on the remaining principal, so it decreases each month.

Currently, most mortgages use the annuitized scheme, so the examples below refer to it.

Two Methods of Early Mortgage Repayment

Early repayment can be done in two ways: by shortening the loan term or by reducing the monthly payment. The economic benefit is not the same in each case.

The choice depends on what the borrower wants to achieve: closing the loan faster and saving on interest, or reducing the monthly financial burden.

At first glance, shortening the term seems more profitable, allowing you to pay less interest. However, in recent years, economic instability has made it risky to assume a steady income. Therefore, if your debt load is high, it makes sense first to reduce the monthly payment to a comfortable level before considering shortening the term.

Why Early Repayment Is Most Profitable Early in the Loan Term

In annuitized payments, the initial 80/20 ratio means that the earlier you start repaying ahead of schedule, the more money you save. The total overpayment is minimized if early repayment occurs in the first 3–5 years.

Regardless of which repayment method you choose, it’s best to make the extra payment immediately after your regular monthly payment is debited. This ensures the full extra payment reduces the principal.

If you make the payment before or a few days after the scheduled date, part of it may go toward paying interest accrued since the last installment, so the debt reduction will be less noticeable. If the extra payment is much smaller than the regular payment, it could entirely go toward interest, leaving the principal unchanged.

Reducing Monthly Payment vs. Shortening the Loan Term

When you have extra funds to pay off part of the debt, you can reduce the total interest paid by either method:

• Shortening the loan term: The bank charges interest daily on the remaining principal. The shorter the term, the smaller the overpayment. Early repayment may also allow you to cancel additional services required by the contract, such as annual life insurance policies.
• Reducing the monthly payment: Extra payments reduce the outstanding principal, but monthly payments decrease, so interest continues accruing for longer. The overpayment reduction is smaller than with term reduction, but it still provides a benefit. This option is useful if you need to lower your monthly financial burden due to reduced income or higher expenses.

Even if your current payments are manageable, it’s recommended to allocate no more than 30% of your monthly budget to loans. If a larger share goes to banks or MFIs, lowering monthly payments reduces the risk of overdue payments during unexpected financial difficulties.

Timing Extra Payments

The earlier you make an extra payment, the more you save. The bank immediately recalculates the remaining principal and charges less interest.

Near the end of the loan term, most interest has already been paid, so extra payments save less on total interest.

When scheduling extra payments, remember that it does not replace your regular installment. For example, if payments are due on the 5th of each month, making an extra payment on the 3rd does not replace the 5th payment. Ensure you have enough funds for the regular payment to avoid overdue charges.

The best strategy is to schedule extra payments on the same dates as regular payments. This way, the full amount goes toward reducing the principal. Otherwise, part of the payment will cover interest accrued since the previous payment, and the principal will decrease less noticeably.

Frequency of Extra Payments

You can make additional payments as often as allowed by your contract, even monthly. If there are no restrictions, you can choose whether to reduce the term or monthly payment with each contribution. For example, you may first lower monthly payments to maintain affordability, and later focus on shortening the term to save more on interest.

However, you must notify the bank in advance that you are making an extra payment. Otherwise, the bank may debit the regular installment and not recalculate the remaining principal.

Main Takeaways

• Extra payments can be applied either to reduce the monthly payment or shorten the loan term.
• Shortening the loan term maximizes interest savings; reducing monthly payments reduces financial burden.
• Extra payments are most beneficial when made early in the loan term.
• Schedule extra payments to coincide with regular installments to ensure the maximum principal reduction.
• Notify the bank before making extra payments to ensure proper recalculation of the remaining balance.

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