What paying an extra $100 a month actually does

Overpaying a loan is one of the few pieces of personal finance where the advice is simple and the mechanism is genuinely interesting. An extra $100 a month can take years off a mortgage. But it does not do that because $100 is a lot of money. It does it because of where the money lands.

Every payment is split, and the split moves

A fixed-rate loan has a fixed monthly payment, but the payment is not one thing. Each month, interest is charged on whatever you still owe, and whatever is left of your payment reduces the balance.

Early on, the balance is large, so the interest charge is large, so very little of your payment goes to principal. On a 30-year mortgage the first payment can be more than two-thirds interest. By the final year almost the whole payment is principal.

An overpayment skips the queue

When you pay extra and it is applied to principal, that dollar is not buying you a month of borrowing. It permanently removes itself from the balance — which means it also removes every future interest charge that dollar would have generated, for the entire remaining life of the loan.

A dollar overpaid in year two of a 30-year loan avoids 28 years of compounding. The same dollar in year twenty-eight avoids two. This is why overpayment calculators show such dramatic savings for early payments and such modest ones later.

It is also why the advice “round your payment up” is better than it sounds. The amount is small; the timing is what does the work.

Two things that can quietly break it

• The lender may not apply it to principal. Some servicers treat extra money as a prepayment of next month’s scheduled payment, which does almost nothing. Others hold it in suspense. You usually have to say explicitly that it is principal-only. Our extra payment calculator assumes it is applied immediately, and says so.
• Prepayment penalties. Rare on modern residential mortgages, more common on car loans and some commercial lending. Worth five minutes with your loan agreement before you start.

When not to do it

The maths above is about the loan in isolation, and a loan is never in isolation. Paying down a 6% mortgage while carrying a 24% credit card balance is a losing trade. So is overpaying a mortgage with money that should be an emergency fund, because the equity is not accessible when the boiler fails.

We are not going to tell you what to do with your money — we do not know your situation and would only be guessing. What the calculator can tell you is exactly what the trade is worth in dollars and in months, which is the input you actually need.