# Overpaying a loan: shorten the term or lower the payment?

> The bank asks which one when you make a lump-sum overpayment. The choice changes the saving several times over, and the bank's default is rarely the better one.

You overpay a loan with a one-off amount. The bank asks what to do with the
schedule: keep the payment and shorten the term, or keep the term and reduce
the payment.

The question sounds technical. The difference in cost is not.

## Why they are not the same

Interest accrues on the outstanding balance for every month that balance
exists. The overpayment reduces the balance identically in both cases — the
difference is **how long** you keep paying.

**Shortening the term** leaves the payment unchanged, so the balance falls at
the previous pace and the loan ends earlier. Fewer months with interest means
less interest.

**Lowering the payment** spreads a smaller balance across the same number of
years. You pay less each month, but for longer — and hand the lender more in
total.

On a mortgage with a dozen or more years to run, the gap between the two can
exceed the overpayment itself several times over.

## Example: 20 000 off a 300 000 mortgage

A balance of 300 000 at 6% a year with 240 monthly payments left gives a
payment of 2 149.29. Overpay 20 000 and compare:

- **Shorter term:** the payment stays at 2 149.29 and the loan ends after
  212 payments instead of 240. Interest from here on: 174 102.
- **Lower payment:** the payment drops to 2 006.01 for the same 240 months.
  Interest from here on: 201 442.

The same 20 000 saves 27 340 more interest when it shortens the term — more
than the overpayment itself. The 143 a month that the lower payment frees
up is real, but it is bought at a high price.

## When lowering the payment still makes sense

Arithmetic is not the only criterion. Reducing the payment makes sense when:

- **the budget is tight** and a lower payment genuinely reduces the risk of
  coming up short in a bad month — losing liquidity costs more than interest;
- **an income change is coming** — parental leave, going self-employed, a job
  change;
- **you want to increase borrowing capacity** before another obligation,
  because capacity is decided by the total of payments, not the total of
  balances.

Otherwise, shortening the term is cheaper.

## When overpaying is not worth it at all

Before you overpay, check three things.

**The rate on your other debts.** Overpaying a mortgage while carrying a credit
card balance is an expensive mistake — the card costs several times more.

**Your emergency fund.** Money put into a loan stops being available.
Overpaying at the cost of the fund often ends with the first breakdown being
covered by a more expensive loan.

**Early repayment fees.** Rules vary by country and product; read your own
agreement rather than assuming.

## How to work it out yourself

You need three numbers from the agreement: the outstanding balance, the
interest rate and the number of payments left. With those you can compare both
options and see the difference in total interest, instead of relying on a
hunch.

It is worth doing this **before** talking to the lender. The overpayment form
usually has one option pre-selected, and the default is not the one that is
better for you.

---

Źródło: https://ordiarion.com/blog/overpay-loan-shorter-term-or-lower-payment