On home mortgages, a large payment to principal reduces the loan
balance, and with it the “fully-amortizing monthly payment”, or FAMP.
FAMP is the level monthly payment required to repay the mortgage fully
over its remaining term. Many borrowers would like a mortgage on which
the monthly payment would drop to the new lower FAMP following a large
payment to principal, and are disappointed when they find they don’t
have one.

The rules governing payment adjustments following extra principal
payments vary with the type of mortgage. Fixed-rate mortgages (FRMs),
adjustable rate mortgages (ARMs), and home equity lines of credit
(HELOCs) all work differently in that regard.

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Fixed-Rate Mortgages (FRMs)__

FRMs are the most rigid in that extra payments do not affect the required monthly payment at all. For example, if you borrow $100,000 for 30 years at 3%, your FAMP is $422. Pay this amount every month, and you pay off the loan in 30 years. If you make an extra payment of $10,000 in month 2, your payment in month 3 and all subsequent months remains $422. Your loan will pay off in month 305 instead of month 360, but until then, you receive no payment relief.

Of course, the lender can always agree
to modify the contract, and some will do it for a fee. For example, the
payment could be dropped to $379, which is the new FAMP following the
$10,000 payment to principal.

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Mortgages With an Interest-Only Option__

There is one
exception to the rigidity of FRMs noted above. If the FRM is
interest-only for a period, which many were prior to the financial
crisis, the payment should decline in the month following an extra
payment. For example, if the $100,000 loan at 3% was interest only in
month 2 when the borrower made a $10,000 payment to principal, the
interest payment should decline from $250 to $225 the following month.

In many cases, however, the payment adjustment was delayed because the
lender’s servicing system could not handle the transaction properly.
Such delays could range anywhere from a few months to the end of the
interest-only period, which usually was 5 or 10 years. Interest-only is
no longer an option on prime mortgages, and few new ones are being
written.

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Adjustable Rate Mortgages (ARMs)__

With an ARM on
which the borrower is making the FAMP, extra payments change the monthly
payment at a rate adjustment. That happens in month 37 on a 3/1 ARM,
month 61 on a 5/1 ARM, month 85 on a 7/1 ARM, and month 121 on a 10/1
ARM. On the rate adjustment date, the payment is recalculated using the
new rate, the period remaining of the original term, and the outstanding
balance which will reflect any extra payments made in prior months.

Consider a 5/1 ARM for $100,000 at 3%, which has a FAMP of $422. That
payment holds for the first 60 months, regardless of any extra payments
made within that period. If the borrower made an extra payment of
$10,000 in month 2, assuming the 3% rate is unchanged, the new FAMP will
be $379, but the borrower must wait until month 61 to see it.

ARMs become more responsive after the initial rate period ends because
rate and payment adjustments then occur every year or every 6 months.
This means that extra payments reduce the monthly payment within a year
or less.

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Home Equity Line of Credit (HELOC)__

The monthly payment on a HELOC is highly responsive to a large principal
payment. During the initial phase of a HELOC which usually runs for 10
years, the borrower pays interest only, though on new HELOCs some
lenders now require a higher payment. In either case, since the required
payment is a percent of the outstanding balance, a large principal
payment results in an immediate reduction in the required payment.

At the end of the
initial rate period, borrowers enter the payoff period, during which
they must begin paying the FAMP calculated over the remaining life of
the HELOC, usually 20 years. The payment increase required as they
switch into payoff mode is often substantial, since in the typical case
no or very little principal payments had been made during the first 10
years. While a payment larger than the FAMP during the payoff period
will cause the FAMP to decline the following month, this is academic to
HELOC borrowers who have trouble paying the FAMP. __
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Concluding Comment: Do You Really Want a
Payment-Responsive Mortgage?__

Readers should not infer from this article that mortgage payment sensitivity is always a desirable feature. Reducing the monthly payment is a short-run goal that conflicts with the long-run goal of getting out of debt ASAP. While prioritizing the short-run goal is reasonable for borrowers who are having trouble making the current payment, it should be avoided by borrowers who don’t really need payment relief.

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