What Is Mortgage or Principal Curtailment?
Principal curtailment, also known as mortgage curtailment, is a strategy that can help you pay down your mortgage loan ahead of schedule.
Contributing Writer at Tally
April 25, 2022
If you are currently making monthly payments to a lender, one term that you may want to be familiar with is “principal curtailment,” also commonly known as “mortgage curtailment.” These terms are synonymous with one another. They are both a fancy way of saying that you’ve made an overpayment on the amount of principal that you owe on your mortgage.
This article will outline what principal curtailment is, how it works, how it could potentially help you pay down your mortgage faster and the potential downsides associated with the practice.
What is mortgage/principal curtailment?
Principal curtailment, otherwise known as mortgage curtailment, occurs when you make an extra payment on your mortgage loan. By doing so, you reduce your total loan amount. And by reducing your loan balance, you thereby reduce the amount of interest that you’ll owe.
Generally speaking, there are two types of curtailment payments, a partial curtailment and a full curtailment.
A partial curtailment occurs when you pay off a portion of the loan. For instance, let’s say that you receive a tax refund of $1,000 and you decide to apply it to your mortgage. You have $200,000 in principal remaining on your mortgage. After making a curtailment payment, your balance is $199,000. This is known as a partial curtailment.
The other type of curtailment payment is full curtailment. In these cases, you make one lump-sum payment to pay off the remainder of your balance. Based on the example above, this would be the equivalent of making a $200,000 payment.
How does mortgage curtailment work?
There are a few different ways in which you can make curtailment payments. As mentioned above, you can make either partial curtailment payments or full curtailment payments. If you are making partial payments, you can choose to do so regularly or when possible.
For instance, one potential strategy would be to pay a bit extra each month. Let’s say that your monthly payment is $2,000 per month, not including interest. You choose to pay $2,100 per month. If you do this consistently for 20 months, you’ll have essentially knocked off a monthly mortgage payment.
You could also choose to make payments every quarter or year. For example, you could increase your principal payment by $500 every three months.
You can also elect a repayment strategy that is less structured. Instead of making regular payments toward your mortgage, you could instead make additional payments when you’re able to.
An example of this would be if you received a tax refund, as discussed earlier. Putting this bit of extra money toward a mortgage principal reduction not only helps you pay down your loan faster but it can also save you money on interest payments as well.
Regardless of which option you choose, you’ll want to let your lender know that you are applying the funds to the principal. Otherwise, they may consider the funds as an advance of your next monthly payment. For instance, if you add an extra $1,000 to your May payment, your lender may simply apply the $1,000 to your June payment.
By specifying that you are making a mortgage curtailment, you’re informing your lender that the overpayment is meant to go towards your principal and that you still plan to make your next monthly payment in full.
There are a couple of other unique scenarios worth discussing when it comes to principal curtailment. For one, your lender can apply a curtailment to a new loan. This would happen in cases where the lender discovered errors occurred during the close-out process. For instance, if your closing costs were higher than they should be, your lender would correct the mistake by possibly applying the difference as a curtailment to your mortgage.
The other unique scenario may occur during the refinancing process. Specifically, lenders may use a curtailment during a cash-out refinance, if you receive too much money back. Your lender will be able to help you better understand your eligibility requirements and how curtailment will impact your existing loan.
How can principal curtailments help you pay down your mortgage faster?
Principal curtailment could be a useful strategy for homeowners. Let’s say that you have a 30-year mortgage. The amount you owe is divided up into 360 monthly payments. By paying down additional principal, you can potentially reduce how long you have to repay your loan.
Let’s say, for example, that you pay $2,000 per month in principal. Your total mortgage value is $720,000 and you spread this over 360 equal payments.
Now, let’s say that instead of paying $2,000 per month, you instead make a monthly payment amount of $2,100. It will take you 342.86 months to pay off your principal balance (let’s call it 343 months). You essentially knocked 17 months of payments off your mortgage — nearly a year and a half — just by putting an extra $100 toward your principal each month. This, in turn, can help you reach financial freedom, as it frees up cash more quickly.
This can also reduce how much you owe in interest. Mortgage lenders typically calculate interest at the end of each month based on your outstanding balance. By paying off a portion of your home loan ahead of time, you will ultimately reduce the total amount of interest that you owe.
Additionally, based on our last example, you will save yourself from having to pay interest on 17 additional payments. Depending on your interest rate, this can result in savings of thousands of dollars.
Are there any downsides to principal curtailment?
There are a couple of downsides to mortgage curtailment that you may want to consider. First and foremost, you should check the fine print on your loan to make sure it’s possible to pay off your mortgage early without being charged prepayment penalties. Many lenders have waived prepayment penalties on mortgages but you may want to check the terms and conditions on your loan to be sure.
If there are stipulations, they may not be in place for the entire loan term. For instance, your lender may not allow you to pay off the loan until after the first 24 months have passed. Your lender can work with you to determine how making an extra mortgage payment will impact your loan based on your unique financial situation.
The other potential downside to principal curtailment is that you may end up owing more money on your taxes. The IRS allows you to deduct mortgage interest from your taxes. However, because you're paying the principal more aggressively, you won’t be charged as much in interest. So, if you suddenly start paying down your outstanding principal, you should be aware of the potential tax implications.
Being aware of your mortgage payments can help when managing finances
When it comes to managing your personal finances, it’s important that you have a strategy in place. The same logic can certainly apply to your mortgage loan.
To recap, principal curtailment, also commonly referred to as mortgage curtailment, occurs when you reduce the principal balance on your mortgage ahead of schedule. You can do this by making extra payments throughout the year, such as once a quarter or once a year. You can also do this by paying a bit extra each month. This reduces the principal amount, which thereby reduces the life of the loan and the total interest paid.
If you’re looking for more tips and tricks to help you manage your personal finances, be sure to subscribe to the Tally† newsletter. We send the newsletter directly to your inbox, allowing you to keep up to speed with the latest financial management strategies.
†To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. The APR (which is the same as your interest rate) will be between 7.90% and 29.99% per year and will be based on your credit history. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 - $300.