When you have extra funds and want to put them towards your loan, banks usually offer two options: either your monthly installment amount decreases, or your installment stays the same while the term (duration) of your loan is shortened. Financially, the most rewarding method is usually the term shortening option. But exactly how much interest can you save by shortening the term? In this article, we'll break down the mechanics of term shortening, its effect on interest calculation, and how you can figure out your exact savings.
How Does the Term Shortening Process Work?
Loan installments consist of a combination of interest and principal payments. In the early installments, the interest portion is very high; as months pass, the interest portion decreases and the principal portion increases. When you make an extra payment in the middle of your loan, this amount is deducted directly from your remaining principal.
If, after this payment, you say "keep my installments the same, shorten my term," the bank divides your new, reduced principal by your current installment amount. Because your main debt has shrunk but your installment amount remains high, the number of months (term) required to finish paying off the debt naturally decreases. Reducing the term means the interest you would have paid for those future months is completely wiped out.
To see this effect clearly, you can use the Kredi Ara Ödeme ve Vade Kısaltma Hesaplama tool to test your own loan details.
Factors Affecting Interest Savings
The amount of savings you'll achieve by shortening the term is not fixed; it varies based on a few key factors:
1. Timing of the Extra Payment
The biggest interest savings are achieved with extra payments made in the first months or years of the loan. For example, a 50,000 extra payment made in the 10th month of a 120-month loan will wipe out much more interest compared to the same payment made in the 90th month. This is because the pool of interest to be paid in the early months is much larger.
2. Interest Rate
The higher the interest rate you agreed upon when taking out the loan, the greater the savings you'll realize by shortening the term. Getting rid of high-interest loans as early as possible maximizes the money that stays in your pocket.
3. Extra Payment Amount
Naturally, the larger your extra payment, the more your principal decreases, the more your term is shortened, and your savings increase proportionally.
Example Calculation Scenario
Let's look at a concrete example:
- Loan Amount: 200,000
- Term: 36 Months
- Monthly Interest Rate: 3.00%
- Monthly Installment: Approx. 9,870
- Total Repayment (From Start): Approx. 355,000
Scenario: After paying exactly 12 months of the loan, you receive 40,000 and want to make an extra payment.
At the end of the 12th month, your remaining principal is roughly 155,000. When you make a 40,000 extra payment, your new principal drops to 115,000.
- Option 1 (Reduce Installment): You keep the remaining 24-month term. Your new installment drops to about 7,300.
- Option 2 (Shorten Term): You decide to continue paying your current installment amount (9,870). In this case, the 115,000 principal will be paid off in about 15 months. Your loan will be completely closed in 15 months instead of 24. The interest for that 9-month difference is completely wiped out.
In this scenario, choosing to shorten the term yields a much higher total interest savings compared to reducing the installment. To see the exact figures for your own scenario, you can use the Kredi Ara Ödeme ve Vade Kısaltma Hesaplama tool.
Things to Consider
Before opting to shorten your term, you should consider the following points:
- No Monthly Budget Constraints: If paying 9,870 every month doesn't strain your budget, you should definitely choose to shorten the term. However, if you're struggling with monthly payments, keeping the term the same and lowering the installment can provide psychological and financial relief.
- Mortgage Early Repayment Penalty: Especially with mortgages, an early repayment penalty between 1% and 2% may be charged. This penalty is deducted from the extra payment amount you deposit. When calculating your savings, you must calculate the remaining balance after deducting this commission from the principal.
- Alternative Returns: If you had invested that 40,000 in a deposit account instead of using it to shorten the term, would it have earned more than the loan interest? If the deposit or investment return is lower than the loan interest cost, making an extra payment and shortening the term is the most rational move.
In conclusion, utilizing your available cash with the right strategy can significantly lower the total cost of your loan. Don't forget to get help from professional tools when making your calculations.
