On any loan, your monthly payment is split between two purposes. First, part of your payment covers the interest that has accrued since your last payment. Second, whatever remains goes toward reducing the principal, or the amount you originally borrowed.
This structure explains why making extra payments can be so powerful. Once the interest for a given month has been paid, any additional money goes directly toward reducing your loan balance. That lower balance then reduces how much interest accrues in future months, leading to meaningful long-term savings.
Why Extra Payments Save Money
The real benefit of extra payments comes from what happens afterward. When your balance decreases, interest is calculated on a smaller amount each month. As a result:
- You owe less interest going forward
- More of each regular payment goes toward principal
- Your loan balance drops faster
- Your loan term shortens
These effects compound over time. Each extra payment reduces future interest, allowing even more of your standard payment to reduce principal. This snowball effect can significantly lower total interest costs and accelerate payoff.
This strategy is especially effective on long-term loans, such as 30-year mortgages. If you have many years remaining, small changes made early can lead to large savings.
How Amortization Works Against You
Most loans are amortized, meaning early payments are heavily weighted toward interest. As the loan balance declines, the portion of each payment going toward interest decreases.
Because interest is highest at the beginning of a loan, extra payments made early are especially valuable. You reduce the balance when interest costs are at their peak, cutting off future interest before it compounds.
Example of Saving Money by Adding to Monthly Payments
Suppose you take out a mortgage for $240,000 at 4 percent annual interest with a 30-year term. Your monthly principal and interest payment would be $1,145.80.
In the first month, interest is calculated at roughly 0.33 percent, or $800. The remaining $345.80 reduces your balance to $239,654.20. In the second month, interest drops slightly to $798.85, and $346.95 goes toward principal.
If you make only the minimum payment for 30 years, you will pay a total of $172,486.82 in interest.
Now imagine adding $200 per month. In the first month, you still pay $800 in interest, but reduce the balance by $545.80 instead. The next month, interest drops further, and more of your payment goes toward principal.
By consistently adding $200 each month, you would pay off the mortgage 88 months early and reduce total interest paid to $124,979.70, saving $47,507.12.
Takeaway
Making small, consistent extra payments can produce outsized results. By lowering your balance earlier, you reduce interest costs and allow more of each payment to work in your favor. Even modest increases, such as rounding up payments or applying bonuses or tax refunds, can dramatically shorten your payoff timeline and improve long-term financial flexibility.