A borrower has a $400,000 mortgage at 5% annual interest, amortized over 25 years. If they make an additional principal payment of $10,000, what is the primary benefit?

Q: What is the correct answer to: A borrower has a $400,000 mortgage at 5% annual interest, amortized over 25 years. If they make an additional principal payment of $10,000, what is the primary benefit?

The correct answer is They will pay less total interest and shorten the amortization period. Option B correctly identifies the dual primary benefit of additional principal payments. When $10,000 is applied directly to principal, it reduces the outstanding balance from $400,000 to $390,000. Since mortgage interest is calculated on the remaining principal, this reduction means less interest will accrue over the remaining amortization period. Additionally, with the same monthly payment continuing, more of each payment goes toward principal rather than interest, effectively shortening the time needed to pay off the mortgage completely.

Q: What background knowledge is needed for this Mortgage & Real Estate Finance question?

Mortgage prepayment privileges allow borrowers to pay down principal faster than the regular amortization schedule. Most Canadian mortgages include prepayment options, typically 10-20% of the original principal annually. Interest is calculated on the outstanding principal balance, so reducing this balance through prepayments directly reduces future interest costs. The amortization period represents the time needed to fully repay the mortgage at regular payments. Prepayments effectively accelerate this timeline while maintaining the same payment schedule, unless re-amortization is requested.

Q: What is a good way to remember the answer to this Mortgage & Real Estate Finance question?

Remember SPLIT: Savings (on interest), Principal (reduction), Less (total interest), Interest (calculated on remaining balance), Time (shortened amortization). When you make extra principal payments, you SPLIT the benefits between saving money and saving time. When you see prepayment questions, think SPLIT to remember that extra principal payments create a split benefit: you save on total interest costs AND reduce the time to pay off the mortgage completely.

Q: What exam tip applies to this Mortgage & Real Estate Finance question?

Look for questions about 'primary benefit' of prepayments - the answer combines interest savings AND shortened amortization. Avoid options suggesting immediate payment changes or rate modifications.

Q: How does this Mortgage & Real Estate Finance concept apply in real world practice?

A client receives a $15,000 bonus and asks whether to invest it or apply it to their mortgage. As their agent, you explain that applying it to the mortgage principal would save them approximately $45,000 in interest over the remaining amortization and shorten their mortgage by about 3 years. This knowledge helps you provide valuable financial guidance while demonstrating expertise in mortgage mechanics to build client trust and potentially generate referrals.

Question

Mortgage & Real Estate FinancePrepayment BenefitsONMEDIUM

A borrower has a $400,000 mortgage at 5% annual interest, amortized over 25 years. If they make an additional principal payment of $10,000, what is the primary benefit?

Answer Options

A

Their monthly payment will decrease immediately

B

They will pay less total interest and shorten the amortization period

C

Their interest rate will be reduced by 0.25%

D

They will qualify for a lower stress test rate