Extra payments on ARM pay off

Don't believe everything your loan officer tells you
Published on Nov 30, 2010

Q: "My loan officer has told me that on a 5/1 adjustable-rate mortgage (ARM), paying $1,000 more each month for 60 months won't generate any savings over paying $60,000 in month 60, just before the interest rate and payment reset. Is this true?"

A: No, he is wrong. If you pay an extra $1,000 a month for 60 months, the loan balance will be smaller in month 60 than if you applied $60,000 to the balance in month 60. The reason is that extra payments received early reduce the balance early, which reduces the monthly interest due on all future payments, which increases the portion of all future payments that is applied to principal.

The higher the interest rate, the larger the savings. For example, at 5 percent, paying an extra $1,000 a month on a $300,000 loan will result in a loan balance 3.7 percent smaller after 60 months than applying $60,000 to the balance in month 60. At 10 percent, the balance would be 7.6 percent lower.