When you come into a lump sum of money while paying off your loan, you might want to put that money toward your loan to lighten your monthly payment burden. One of the most popular methods when making an extra payment is to keep the remaining loan term fixed and reduce the monthly installment amount. But exactly how is this new monthly installment calculated after your payment? In this article, we'll dive deep into the logic behind reducing installments and what you need to look out for.
The Logic Behind Reducing Installments After an Extra Payment
When you take out a loan, the bank divides the principal you are borrowing based on the specified interest rate and term using the "annuity" (equal installment) payment plan. When you make an extra payment at some point during your loan, the amount you pay is directly deducted from your remaining principal at that moment.
To calculate your new installment, the bank uses the following data:
- New (Reduced) Principal: Your extra payment amount is subtracted from the current principal (after any early payment penalties are deducted, if applicable).
- Remaining Term: How many months are left until your loan ends.
- Current Interest Rate: The interest rate you agreed upon when you first took out the loan (this rate does not change unless you refinance).
The bank takes this new, lower principal and recalculates it as if you were taking out a brand new loan for that amount over the remaining term, using the same interest rate.
To see your exact numbers, you can use our Kredi Ara Ödeme ve Vade Kısaltma Hesaplama tool.
The New Installment Calculation Formula
The equal-installment loan calculation formula used by banking systems is as follows:
Installment Amount = Principal * (Interest Rate * (1 + Interest Rate)^Term) / ((1 + Interest Rate)^Term - 1)
When you make an extra payment, the Principal value in the formula decreases by the amount you deposited. The Term is the number of remaining months.
A Realistic Example Scenario
Let's use an example to clarify the concept:
- Loan Amount: 150,000
- Term: 24 Months
- Monthly Interest Rate: 2.50%
- Current Monthly Installment: Approx. 8,420
Let's say after paying the 6th installment of your loan, you receive 30,000 and make an extra payment to the bank.
Step 1: Finding the Remaining Principal
You've paid installments for 6 months, but a portion of those payments went to interest. At the end of the 6th month, your remaining principal is roughly 118,000.
Step 2: Calculating the New Principal
When you make a 30,000 extra payment;
New Principal = 118,000 - 30,000 = 88,000.
Step 3: Calculating the New Installment
The bank recalculates the 88,000 debt over the remaining 18 months (24-6) at the 2.50% interest rate.
Your new installment will drop to approximately 5,950.
As you can see, a 30,000 extra payment has significantly eased your family budget by reducing your monthly payment burden from 8,420 to 5,950. You can try out the Kredi Ara Ödeme ve Vade Kısaltma Hesaplama tool to simulate this process.
Who Should Choose to Reduce Installments?
When making an extra payment, the question often arises: "Is it more logical to shorten the term or reduce the installment?" You should opt to reduce the installment in the following situations:
- If There's a Drop in Monthly Income or Increase in Expenses: If the high loan installments you're paying every month have started to strain your budget.
- If You Want to Ease Cash Flow: If you want more cash to stay in your hands every month and plan to use this cash for different short-term needs.
- Paying Debt in an Inflationary Environment: In a high-inflation environment, keeping the same term ensures that the real value (purchasing power) of the installments paid in future years will decrease. In this case, reducing the installment might seem more attractive.
Limitations to Consider
- Lower Total Interest Savings: While reducing installments eases the monthly budget, because the term remains long, the total interest amount you will pay to the bank will be higher compared to the term shortening option.
- Commissions: If you are making an extra payment on a mortgage, your bank may charge an early payment commission, provided it doesn't exceed legal limits (1% or 2% depending on the term). This deduction is taken from the extra payment amount you deposit before the rest is subtracted from the principal. Personal and auto loans generally do not have such a commission.
In summary, knowing what your new installment will be after an extra payment is critical for your budget planning. Before making a decision, be sure to run different simulations to determine the best strategy for you.
