Taking out a loan is a common method for making large investments or covering urgent cash needs. However, when you come into a lump sum of money while your loan is still active, you might want to use it to make an extra loan payment. But is making an extra payment really advantageous? When should you do it? In this article, we will examine the logic behind extra loan payments, their impact on your interest burden, and the best timing strategies. We will also introduce our Kredi Ara Ödeme ve Vade Kısaltma Hesaplama tool, which you can use while planning this process.
What is an Extra Loan Payment?
An extra loan payment is an additional payment you make outside of your regular monthly installments, specifically intended to reduce your principal debt. Loan payments are usually calculated using the "annuity" method; meaning a portion of each monthly payment goes toward the principal, and the rest goes toward interest. In the early years of a loan, the interest portion is high, and the principal portion is low. Towards the end of the term, this situation reverses.
When you make an extra payment, the amount you pay is deducted directly from your remaining principal. A reduction in the principal means a reduction in the interest that will accrue in the future. This provides you with significant savings on the total repayment amount.
Advantages of Making Extra Payments
The main advantages of making extra loan payments are:
1. Getting Rid of the Interest Burden
The biggest advantage of an extra payment is that it reduces your total interest burden. Because your principal decreases, the interest the bank calculates on that amount also decreases. Especially with long-term and high-value loans like mortgages or auto loans, even a small extra payment can save thousands in interest.
2. Option to Shorten the Term or Lower Installments
After making an extra payment, you generally have two options:
- Shorten the Term: You can bring forward the end date of the loan without changing your monthly installment amount. This method maximizes your total interest savings.
- Lower the Monthly Installment: You can keep the loan term (end date) the same and reduce the monthly installment amount you pay. This method is ideal if you want to ease your monthly budget.
To see which option is more advantageous for you, you can use our Kredi Ara interventions and Term Shortening Calculator.
3. Psychological Relief
Reducing the debt burden and knowing the loan will end sooner provides significant psychological relief for many people. It helps you reach financial freedom faster.
When Should You Make an Extra Payment? The Importance of Timing
Whether an extra payment is advantageous also depends on when it is made. The interest burden on loan payments is generally much higher in the first few months (or years).
Making Extra Payments in the Early Years of the Loan
If you are still at the beginning of your loan (e.g., in the 20th month of a 120-month mortgage), making an extra payment is highly advantageous. Because during this period, a large portion of your monthly installments is interest. An early extra payment provides maximum savings as it will wipe out the interest of many future installments.
Making Extra Payments in the Final Years of the Loan
If there is little time left until your loan ends (e.g., only 10 installments left), the interest portion in your installments has already decreased significantly, and the principal portion has increased. At this stage, making an extra payment does not make a huge difference in terms of interest savings. It might be more profitable to invest your lump sum in a different investment vehicle (deposits, gold, funds, etc.).
Example Calculation and Scenario
Let's say you took out a personal loan of 100,000 with a 36-month term and a 3.00% monthly interest rate. Your monthly installment will be approximately 4,935.
In the 12th month of the loan, you receive a lump sum of 20,000 and want to make an extra payment.
- If you keep the term the same: Your monthly installment for the remaining 24 months will decrease, easing your monthly budget.
- If you keep the installment the same and shorten the term: Your loan will end much sooner than 24 months, and you will achieve significant interest savings.
Doing these calculations manually is quite difficult. Potential commissions (early payment penalties, etc.) that your bank might apply must also be taken into account. Therefore, to compare different scenarios, you should definitely use the Kredi Ara Ödeme ve Vade Kısaltma Hesaplama tool for detailed planning.
Things to Consider and Limitations
- Early Payment Penalty (Commission): Personal loans generally do not have an early payment penalty. However, for mortgages, banks are legally allowed to demand an early payment compensation of 1% for loans with a remaining term of up to 36 months, and 2% for loans exceeding 36 months. You must include this commission in your costs when calculating the advantage of an extra payment.
- Alternative Investment Return (Opportunity Cost): If the interest return you would get by investing the extra payment amount in a risk-free investment like a deposit account is higher than the cost (interest) of your loan, it might be mathematically more logical to keep the money invested. Especially in inflationary environments, instead of paying off a fixed-installment, low-interest loan early, it can be more profitable to direct the money to instruments that protect against inflation.
In conclusion, making an extra loan payment is highly advantageous, especially in the early periods of the loan and if you borrowed at high-interest rates. To make the best decision for your financial situation, we recommend creating different simulations using the Kredi Ara Ödeme ve Vade Kısaltma Hesaplama tool.
