Many homebuyers finance their home purchase with a mortgage that’s paid back over a specific term, often 15 or 30 years. Borrowers may seek to pay off the loan ahead of schedule, a process known as mortgage curtailment, with the goal of saving on interest and getting out of debt.
Before you start making extra payments on your home loan, let’s take a closer look at curtailment mortgage meaning, its potential benefits, and factors to consider.
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How Mortgage Curtailment Works
At a high level, curtailment in mortgage involves additional payments on the mortgage principal to reduce the length of the home loan and pay off a mortgage early. Monthly mortgage payments have four components: principal, interest, taxes, and insurance.
When you make your first mortgage payment, and for the initial portion of your loan, a greater share of the payment goes toward interest. As the principal balance gets paid off, less interest accrues and a greater share of the payment goes toward the principal. Mortgage curtailment speeds up this process by applying extra funds to the principal on top of the monthly payment. This is why it’s sometimes called “mortgage principal curtailment.”
The decision to curtail a mortgage is usually up to the borrower. Occasionally, mortgage principal curtailment can occur to refund overpayment of fees or during a cash-out refinance to bring the loan into compliance.
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Differences Between Curtailment and Prepayment
If you’re thinking about mortgage curtailment, you may also run across the term “prepayment,” a general term for making early payments on a loan. A mortgage prepayment could be a curtailment (in which you pay off some of the principal — but not all that you owe — early). Or it could be a complete prepayment of the loan, in which you pay off the entire amount of principal owed. So in short, curtailment is a form of prepayment and the terms are often used synonymously.
Benefits of Mortgage Curtailment
Paying off a home loan early with mortgage curtailment has its advantages. Notably, borrowers can potentially save thousands of dollars on interest by whittling away at the principal early.
Taking out a 15-, 30-, or even 40-year mortgage can be daunting. But chipping away at the principal with extra payments can shave years off the loan term. Besides offering peace of mind, getting out of mortgage debt frees up cash for other financial goals.
Putting more money toward the mortgage principal also builds home equity faster than making only your monthly payments. Greater home equity can increase net worth and boost the return on investment should you decide to sell your home. Additionally, homeowners can leverage their home equity for a variety of loans, whether for repairs and renovations or to purchase a new property before selling their home.
Calculating Mortgage Curtailment Savings
To understand how curtailment helps save money, let’s crunch the numbers with a principal curtailment mortgage example. Suppose a borrower has a $350,000 home loan with a 30-year term and 5.00% interest rate. If the homeowner made regular monthly payments, this would amount to $313,339 in interest over the life of the loan.
In this scenario, tacking on an extra $100 to the $1,804 monthly payment and applying that toward the principal would save $40,614 in interest and reduce the loan term by almost four years. Meanwhile, contributing an additional $400 to the principal each month would translate to $114,759 less in interest payments and paying off the mortgage in under 21 years.
Using a mortgage calculator can help estimate your monthly payment and how much interest you’d pay without mortgage curtailment.
Factors to Consider Before Curtailing
While curtailment can help save on interest and shorten the loan term, it’s important to take your personal financial situation into account. Any high-interest debt, such as credit cards, would be worth addressing first before allocating funds toward extra payments on a mortgage principal. It’s also good practice to have some cash reserves set aside for an emergency fund prior to curtailing a mortgage.
Here are some other factors to consider in the decision-making process.
Prepayment Penalties
Paying off a mortgage early can come with a cost — literally. Depending on the mortgage agreement, borrowers may be on the hook for covering a prepayment penalty, a fee imposed by the lender to offset the loss in interest income the lender will experience if a borrower prepays.
Different types of mortgages have varying terms and requirements. Reach out to your lender or check the fine print to see if prepayment penalties apply.
Opportunity Costs
Putting more money toward the mortgage principal is one way to increase wealth and get out of debt. But it’s worth considering the opportunity cost of mortgage curtailment versus using funds for other financial goals, such as retirement savings.
The money used for curtailment mortgage could potentially get a higher return on investment if invested in stocks, a Roth 401(k), or other retirement fund. When comparing how much interest you might save through mortgage curtailment vs. estimated earnings from investments, it’s important to factor in how much you expect the property to increase in value, as you will be building equity, not just saving on interest charges.
Tax Implications
Homeowners who itemize deductions on their tax returns can claim what they paid in mortgage interest, capped at a maximum of $750,000 in debt. The mortgage interest deduction also extends to home equity loans or lines of credit if the money borrowed is used for home improvements.
If total write-offs don’t exceed the standard deduction amount ($14,600 for single or married filing separately and $29,200 for married filing jointly), then an itemized deduction may not be worth it.
Strategies for Mortgage Curtailment
Borrowers have options for their mortgage curtailment strategy. Partial curtailment involves making additional payments (which might be monthly, or another frequency) on the loan principal. Borrowers still make regular monthly payments until the loan is paid off, but with each added payment, the mortgage amortization is updated to reflect the reduced principal balance. This approach offers flexibility for homeowners to adjust their extra payments based on their financial situation.
Alternatively, borrowers can pursue total curtailment to pay off the entire outstanding mortgage principal in one lump sum. Depending on how much you owe, this could require significant savings, or a windfall from, say, an inheritance.
Alternatives to Mortgage Curtailment
There are other ways to save on a mortgage that are worth looking into as you consider whether curtailment is right for you.
To take advantage of lower interest rates, homeowners can consider a home loan refinance. When doing so, choosing a mortgage term that’s shorter can save on interest payments over the life of the loan.
Borrowers who put less than 20% down on a house are required to pay private mortgage insurance (PMI) until they reach 20% equity. Making additional payments can put borrowers on a path to hitting 20% and getting out of PMI early, at which point they can decide if mortgage curtailment is a worthwhile long-term strategy.
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The Takeaway
Mortgage curtailment involves making extra payments to reduce the principal on a home mortgage loan. Mortgage curtailment can reduce the total interest paid on a home loan as well as the loan term. It’s important to evaluate how curtailment impacts other financial goals, such as building up an emergency fund and saving for retirement, before making an extra payment on your home loan.
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FAQ
What is the difference between mortgage curtailment and prepayment?
People often use the terms interchangeably, but curtailment curtails (shortens) the loan term and the amount of interest you’ll pay. Prepayment might mean making extra payments via curtailment or it could mean paying off the entire loan early.
How much can I save by curtailing my mortgage?
Total savings depends on the loan amount, repayment term, and the timing and amount of additional payments. For example, paying $100 extra each month on a 30-year, $350,000 loan with a 5.00% interest rate would save more than $40,000 in interest payments.
Will curtailing my mortgage affect my credit score?
Making additional payments each month will not affect your credit score. But paying off a mortgage in full reduces your length of credit history which could impact your credit score, although the interest savings might well be worth it.
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