The Effect of Loan Prepayment: Term-Shortening or Payment-Reducing, Which Saves More?

Why prepayment reduces interest

With a regular payment, your money goes to interest first and the rest to principal. With a prepayment, the full amount goes to principal.

Interest is set by "balance at that moment × annual rate ÷ 12", so if principal falls by ¥1 million, every later month's interest is lighter by that ¥1 million's share. The longer the time left until payoff, the longer this lighter state lasts, and the bigger the effect. What you gain from prepaying is this interest you no longer have to pay.

Term-shortening vs payment-reducing

Prepayment comes in two types, depending on whether the reduced principal is used to shorten the term or lower the monthly payment. Here's a comparison for prepaying ¥1 million after 5 years on a loan of ¥30 million over 35 years at an annual 1.0%.

With the same ¥1 million, the term-shortening type saves more than twice the interest. The payment-reducing type recalculates a lower monthly amount without changing the remaining term, so part of the benefit of the lower balance goes toward easier payments instead.

Even so, when education costs pile up or your income looks set to drop, lowering a fixed cost by ¥3,216 a month can matter. Think of them as having different jobs: term-shortening if you're choosing by total cost, payment-reducing if you're choosing by monthly cash flow.

Earlier works better, but the gap isn't as extreme as you might think

This compares the same ¥1 million, changing only the timing (¥30 million, 35 years, annual 1.0%, term-shortening type).

The effect differs by 2.5 times between 1 year and 20 years. That fits the saying that sooner is better, but waiting until year 5 instead of year 1 costs only about ¥54,000. Rather than draining your savings to rush it, it's safer to secure an emergency fund first.

It's also worth seeing what larger amounts do. Prepaying after 5 years saves ¥665,243 in interest with ¥2 million (2 years 7 months shorter), ¥972,123 with ¥3 million (3 years 10 months shorter), and ¥1,536,523 with ¥5 million (6 years 5 months shorter). The effect is roughly proportional to the amount.

The higher the rate, the bigger the effect

Since prepayment reduces interest, it works better on higher-rate loans. Even with the same "¥1 million after 5 years, term-shortening", the effect varies this much by rate.

If you have several loans, the basic approach is to prepay the highest rate first. With a mortgage at 0.5% and a car loan at 3.5%, the same ¥1 million saves more interest on the car loan. The effect of the rate level itself is also covered in interest rates and total repayment.

What to check before you prepay

• Fees: many lenders charge nothing for online procedures, while over-the-counter prepayment can cost from a few thousand to tens of thousands of yen each time. Weigh this against the interest saved.
• Minimum amount: some lenders accept as little as ¥10,000, while others accept only units of ¥1 million.
• Mortgage tax deduction: while 0.7% of your year-end balance is being deducted from income tax, lowering the balance also lowers the deduction. It can be better to prepay after the deduction period ends.
• Emergency fund: money you've prepaid can't be withdrawn. Keep 6 months to 1 year of living expenses on hand.
• Group credit life insurance: mortgages in Japan often include this cover (danshin), and rushing repayment ends the protection sooner. When rates are low, some people prefer investing or saving over prepaying. See how invested money grows in how compound interest works.

Especially during the deduction period, if your rate is below the deduction rate (0.7%), the drop in the deduction can exceed the interest saved by prepaying. You can't tell which side your rate falls on without calculating.

Check the effect with the tool

The "Prepayment effect" tab of the Loan Repayment Simulator calculates the term-shortening and payment-reducing types side by side under the same terms.

1. 1

   Enter the loan terms

   Enter the loan amount, rate and term. The same terms as the "Calculate payment" tab are carried over, so there's no need to re-enter them.

2. 2

   Enter the prepayment amount and timing

   You can type amounts in a form like "100万". For timing, specify how many years after repayment starts, in whole years.

3. 3

   Compare the two types

   For each type, you'll see the interest saved, the time shortened and the monthly payment after the reduction.

4. 4

   Compare timing

   A comparison table also shows the result of prepaying after 1, 3, 5, 10, 15 and 20 years, which helps you decide when to do it.

You can also check the repayment schedule after a prepayment. How the payment itself is calculated is covered in how to calculate loan payments, and the differences between methods in equal payment vs equal principal repayment.

FAQ

How much interest does prepaying ¥1 million save?

On a loan of ¥30 million over 35 years at an annual 1.0%, prepaying after 5 years with the term-shortening type saves ¥341,356 in interest and brings payoff forward by 1 year 3 months. With the payment-reducing type it saves ¥157,926, and the monthly payment drops from ¥84,685 to ¥81,469. At 1.8%, term-shortening saves ¥694,050, so the effect depends heavily on the rate.

Which saves more, term-shortening or payment-reducing?

On interest saved alone, term-shortening wins, by more than twice under the terms above. But payment-reducing lowers your monthly payment, which protects the household budget when income falls or education costs pile up. Choose based on whether you value the total or monthly breathing room more.

Is it better to prepay early?

For the same amount, the earlier the better. Prepaying ¥1 million on ¥30 million over 35 years at 1.0% saves ¥395,706 after 1 year and ¥155,639 after 20 years, a 2.5-fold gap. But each year you wait costs only around tens of thousands of yen. Rather than using up your cash to rush it, it's safer to prepay after securing an emergency fund.

Should I avoid prepaying while I have the mortgage tax deduction?

It depends on the rate. The deduction takes 0.7% of the year-end balance off income tax and similar taxes, so if your loan rate is below 0.7%, the drop in the deduction can exceed the interest saved. If your rate is above 1%, prepaying is generally the better deal even during the deduction period. Check the years left on the deduction and your rate before deciding.

Is it better to prepay a little every year or all at once?

For the same total, a little every year is better because principal falls sooner. But if each prepayment has a fee, that cost builds up with the number of times. A practical split is small, frequent prepayments if your lender offers free online procedures, and a lump sum if there's a fee.