The effect of one or more extra principal payments on a loan, such as a home mortgage, is to shorten the time it takes to pay off the loan. To calculate the number of payments you save, you need a starting point for the loan balance. That value can be either the initial loan amount or the current loan balance after the most recent payment. Hand calculating a payoff requires doing the math for each remaining payment.
Locate the current loan balance, the monthly payment amount and the interest rate for the loan. Rate and payment will be on the contract. The loan balance is typically available on the current monthly statement or can be obtained by calling the bank's customer service phone number.
Calculate the interest charge for the next monthly payment by dividing the annual rate by 12 and multiplying the result times the loan balance. As an example, a $100,000, 15-year loan at 9 percent has a payment of $1,014.27. One year into the loan, the balance is $96,694.62. Dividing 9 by 12, gives a monthly interest rate of 0.75 percent. Multiply that rate times the loan balance shows that the interest charge for the next payment -- number 13 -- will be $725.21.
Subtract the calculated payment interest amount from the scheduled payment to obtain the principal part of the next payment. Add in any additional principal you plan to pay and subtract the total from the loan balance. For the example, subtracting $725.21 from $1,014.27 produces a scheduled principal payment of $289.06. If you added $1,000 in additional principal, the loan balance would decrease to $95,405.56 -- $96,694.62 minus $1,289.06 -- after you send in the payment.
Repeat the interest and principal calculation for each succeeding payment until the loan balance is paid to zero. Interest is always calculated on the new balance, so in the example, after making the $1,000 in extra principal the interest for the next payment would be 0.75 percent times $95,406.56 or $715.54.
With the usual type of loan amortization, the required monthly payment stays level even if you make regular or occasional extra principal payments. The extra principal just reduces the loan balance and the interest charged for subsequent payments. Spreadsheet software can be set up to calculate the principal, interest and balance for each payment. Let the spreadsheet do the repeatable math by setting up the calculation for one payment and then copying the first line or column.
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