Do Mortgage Lump Sums Decrease an Amortization Period?

Fixed-Rate Mortgages

Fixed-rate mortgages maintain the same interest rate and thus monthly payment over the life of the mortgage. Lump sum payments reduce the principal that is paid down with the monthly payment, leaving fewer monthly payments needed to pay off the principal. Lump sums paid when the mortgage principal is still large at the beginning of the mortgage have a greater effect on reducing the number of months needed to pay off the loan. For example, a 15-year fixed-rate mortgage of $100,000 mortgage at 6 percent interest with a lump sum payment of $10,000 in month 10 reduces the number of months to pay off the mortgage by 25 months. The same lump sum paid in month 100 only reduces the number of payments by 16 months.

Adjustable rate mortgages have an initial interest rate that changes periodically, often annually. The monthly payment is recalculated, or reamortized, based on the new interest rate, the balance of the ARM mortgage at that time and the remaining repayment period. Lump sum payments reduce the mortgage balance and thus the impact of an interest rate increase on the monthly payment. Still, because the mortgage is reamortized based on the number of years left in the term of the mortgage, lump sum payments have a greater impact on the monthly payment amount than on the amount of time needed to repay the loan.

Many ARMs have caps limiting how high the monthly payment can rise but if that monthly payment doesn't cover the principal and interest needed to pay down the mortgage, the amount that isn't covered by the monthly payment is tacked on to the mortgage balance thus creating a negative amortization. Eventually, the mortgage would be adjusted to be paid off within the life of the mortgage causing a spike in monthly payment amount. In this case, lump sum mortgage payments made while the monthly payment is capped can reduce the balance that would otherwise increase monthly payments in the future.

Interest-only mortgages have terms that allow the borrower to only pay interest for a certain number of months, after which point the borrower begins to pays off the balance at a significantly higher monthly payment or must pay the balance as a lump sum. Paying lump sums during the interest-only period reduces the balance that must be paid after that period ends and thus potentially the amortization period.

Lump sum payments have less impact on the reducing the repayment period for reamortizing ARMs, and some mortgages include prepayment penalties. Reducing the balance also reduces the amount of interest that borrowers may be able to deduct from their taxes, which may be useful to some borrowers. Finally, it's worth considering if the money invested in lump sum payments would produce a better rate of return if invested in something else.