Mortgages are typically very long-term financing tools, often spanning 120 months (10 years) or more. Over this long period, you might come into a lump sum of cash through a job change, a bonus, an inheritance, or income from other investments. When you put this money toward your mortgage, the bank will ask you a critical question: "Should we reduce your monthly installment, or shorten the loan term?"
Making this decision is not just a mathematical calculation; it's also a step related to your personal financial strategy. In this article, we'll examine in detail which option makes more sense in which situations when making an extra payment on a mortgage. Before making your decision, you can use our Kredi Ara Ödeme ve Vade Kısaltma Hesaplama tool to see different scenarios.
Advantages of Shortening the Term
This is the situation where, after making an extra payment, you keep your installment amount the same (or very close to it) and bring forward the end date of the loan.
Pros:
- Maximum Interest Savings: The vast majority of the total money you pay on mortgages is interest. When you bring the term forward by, say, 3 years, the interest you would have paid the bank for those 3 years stays entirely in your pocket. The biggest financial gain is in this method.
- Paying Off the Debt Early: You rid yourself of the psychological burden of a long-term debt earlier. The bank's lien on your home is lifted faster, and the house becomes entirely yours.
Cons:
- No Relief in Monthly Budget: Because you will continue to pay your current installment amount, you won't feel any relief in your monthly cash flow.
Advantages of Reducing Installments
This is the situation where you keep the term (the end date of the loan) the same, and thanks to the extra payment you deposited, you pay lower installment amounts in the ensuing months.
Pros:
- Monthly Budget Relief: The amount going from your salary to the loan each month decreases. This is a great solution, especially if your income has dropped or if new monthly expenses (child costs, school, etc.) have arisen.
- Advantage Against Inflation: In economies with high inflation, the future value of money is lower than it is today. When you keep the term long and reduce the installment, the installments you pay years later will have "melted" in the face of inflation.
Cons:
- Less Interest Savings: Because the debt is spread over a longer period, the total amount of interest you will pay the bank will be higher compared to the term shortening option.
The Inflation Effect and Decision Criteria
When deciding, the "inflation" factor is very critical in many economies.
If you took out your mortgage in past years at a very low interest rate and the current market interest rates and inflation are well above those rates, making an extra payment might even be mathematically illogical. Because the return you would get by investing that cash in a deposit account or gold would be much higher than the interest you pay on the loan.
If you still decide to make an extra payment:
- Mathematically most profitable: Shortening the term.
- Most logical for managing cash flow: Reducing the installment.
To see these differences with your own numbers, you can enter your current debt, remaining term, and the extra payment amount you want to deposit into our Kredi Ara Ödeme ve Vade Kısaltma Hesaplama tool to compare the costs of both options.
Early Repayment Penalty (Commission) on Mortgages
According to consumer laws in many regions, banks cannot charge an extra payment commission on personal and auto loans. However, the situation is different for mortgages.
Banks legally have the right to charge an "Early Repayment Compensation" over the amount you deposit when you make an extra payment or completely pay off a mortgage.
- For loans with a remaining term not exceeding 36 months (3 years): A maximum of 1% of the deposited amount.
- For loans with a remaining term exceeding 36 months (3 years): A maximum of 2% of the deposited amount.
For example, if you are making a 100,000 extra payment and you have 50 months left on your term, the bank can deduct a 2,000 early payment penalty. In this case, 98,000, not 100,000, is deducted from your principal. You must definitely take this legal deduction into account when making your calculations.
In summary, there is no single right answer to whether the installment should drop or the term should shorten when making an extra payment on a mortgage. You must choose what suits you best based on your own income-expense sheet, the country's inflation situation, and your future cash needs.
