Borrowing an amount of money obligates the buyer to repay the money. The buyer is usually NOT obligated to make a certain number of payments. The loan agreement specifies the exact obligations for that specific loan – refer to that document when making decisions.
The monthly payment is actually a minimum amount which is due each month while there is still principal owed on the loan.
Paying the minimum every month will result in making all the minimum monthly payments for the specified number of months. Paying the minimum and going the distance is the most expensive course of action for the buyer, and sometimes there are other options. Again – review the loan agreement to confirm all options.
Usually there are two ways to make extra payments, and every extra payment should specify for the lender exactly how the payment should be allocated. The two ways are:
- Allocate the amount as an Early Payment
- Allocate the amount to Principal
Sending in an early payment allows the buyer to skip a payment later. When the payment is finally applied, it will satisfy the same interest and principal that the payment would have if it was submitted immediately before being applied. This is good for buyers who have sporadic income and want to build a safety net into their financial plan.
Sending in an extra payment allocated to Principal will immediately reduce the principal of the loan. That amount of principal will stop earning interest for the lender. The buyer must still make the minimum payment amount the next month, but the extra amount which was submitted (and the interest) can satisfy the loan earlier and cost less overall.
Here’s an example which saves $100k by sending extra principal payments monthly – that’s college for 2 kids!
Extra payments can be very powerful. A number of payments listed in the loan documents is NOT the simple end of a story.