Making Mortgage Prepayments
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FacebookI recently received the following question from a reader named Merry that’s interested in paying off her mortgage early.
I have been making an extra regular mortgage payment in the middle of every month. Currently, my next mortgage payment is not due until May 1, 2010. Is this the best way to put extra money toward my mortgage, or should I be specifying the extra money to go toward principal only?
The short answer is that this is not the best way to prepay your mortgage. In fact, all that’s happening here is that the bank is treating these like ‘regular’ payments that got sent in early. Instead of applying the overage to the mortgage principal, they’re holding the money (and pocketing the interest) until the monthly payments are due.
If it were me, I’d call the bank and politely (but firmly) insist that they go back and apply the payments properly. If they refuse, then I’d stop sending in the ‘regular’ monthly payments until they are due (May 2010), and instead focus on principal-only payments along with a note specifying how these funds are to be applied.
As an aside, I’ve never had a problem with a mortgage lender properly applying over-payments to the mortgage principal. In fact, I’ve never even enclosed a note asking them to do so. I’ve just written a larger then necessary check and they’ve taken care of things on their end.
Note that Merry has been “making an extra regular mortgage payment” every month. It’s thus possible that, when the bank received a standalone payment that exactly matched the expected monthly amount, they inadvertently applied it as a regular payment. Either way, it’s definitely worth calling to get it straightened out.
If you are interested in prepaying your mortgage, you can tinker with a mortgage prepayment calculator to determine the impact extra payments would have on your loan and loan term. You can also compare mortgage rates to determine if you can save money over the course of your loan by refinancing to a lower rate – 30 year fixed mortgage rates are averaging 5.11% this week, according to MoneyRates.
Published on November 25th, 2009 - 15 Comments
Filed under: Debt Reduction, Mortgages
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About the author: Nickel is the founder and editor-in-chief of this site. He's a thirty-something family man who has been writing about personal finance since 2005, and guess what? He's on Twitter!
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15 Responses to “Making Mortgage Prepayments”
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November 25th, 2009 at 9:39 am
Some servicers such as CitiMortgage also have a line item where you can specify an additional payment made to principal.
November 25th, 2009 at 10:00 am
I had a similar problem with Citi for my student loans. I sent in a payment that was specifically supposed to go toward paying off my 6.8% loans,not the 1.8% or the 3.5% one. Instead, they applied it equally based on the outstanding amount, so 80% went to my 3.5% loan. I called up and thankfully, they were able to change it after after about a week. Still, on optional payments, institutions should know better. I knew what to look for, but I’m sure lots of people are getting their money stolen.
November 25th, 2009 at 10:20 am
I worked in a bank until very recently. The way we processed multiple payments within one month is that (unless specified) the second payment will not be principle only if not made on the same day as the first payment. This is because these payments are sent for processing separately. If they were made within 24 hours of each other then they would be sent as one payment. As Nickel indicated, if you make one large payment then only one month’s interest will be applied because of this rule. You can try calling and requesting for it to be retro actively applied – tho you might first meet resistance.
November 25th, 2009 at 10:35 am
I had this EXACT same problem with my auto loan:
http://www.myjourneytomillions.....principal/
My auto loan company wouldn’t fix it! So I stopped sending in extra payments for a bit.
November 25th, 2009 at 1:09 pm
The banks always know what they are doing, and it is their system of pocketing the extra interest, Just As You Have Said!
John DeFlumeri Jr
November 25th, 2009 at 2:05 pm
I’d pay once a year, one junk to principal only. It’s easier and more efficient.
November 25th, 2009 at 4:55 pm
Some banks are tricky like that. I agree with you nickel, I would call the bank and see if they would be willing to change the payments received.
I doubt that they will, so I’d send the rest as principal only, May 2010…
Just curious did the read say which bank she was with?
November 25th, 2009 at 8:49 pm
I worked for Wells Fargo Home Mortgage customer service for 4 years. At Wells Fargo, they always posted extra payments that were the exact same amount as the monthly payment as a monthly payment unless otherwise specified on the payment coupon. Wells Fargo wasn’t trying to reap extra interest off homeowners, there were far more people who were purposely paying payments far in advance on purpose than people who were making extra payments in the exact same amount as their payment without specifying where it should go. We were always more than happy to reverse any extra payments erroneously applied towards principle. Here are a couple of tips I learned while working for WFHM:
Don’t sign up for bi-monthly payments if there is a monthly/yearly fee involved, instead send in 1/12th of your monthly payment each month towards principle, you will get the same effect.
Don’t worry too much about late charges, if you’re not over 30 days late you won’t be reported to the credit bureau. Usually you can get a late fee waved by escalating the call to customer service rep’s superior.
Don’t call customer service on a Monday (this can be applied to pretty much any company’s customer service/customer support) and especially don’t call on the 15th of the month, this is when a lot of the procrastinators are calling in to get their payment applied before they’re charged a late charge.
November 25th, 2009 at 11:38 pm
My mortgage specifically states that any extra payments will be applied first to any late charges, then escrow underage and then to principle. I’ve never had any question or failure to apply my extra payments correctly.
On a side note: Boo to Bank of America for losing my Home Owners Insurance info when they converted Countrywide to their system. Then making me jump through 30 mins of useless automated phone system hoops just be be told I would need have my insurance company fax the declaration page to them.
My car loan on the other hand was a constant fight to get them to apply the extra payment to the principle. Every month they would take the extra and deduct it from my next months payment and every month I would have to call them. I finally took a hit on my emergency fund and paid the car loan off in full.
November 26th, 2009 at 7:56 am
I’ve paid 2 mortgages off early. Always write on the extra payment check “apply to principle” and make the extra payments as early as possible, since interest is lower on each subsequent payment.
November 26th, 2009 at 11:03 am
One more item to consider is that there is a tax “issue” regarding paying that far in advance. . . even though you made payments this year, you can’t “pre-pay” interest (tax-deductable). . . so, you don’t get to deduct what you sent in early. . . not sure what the paperwork will look like from the bank at the end of the year, but don’t blindly just copy the numbers into your tax forms- make sure that it doesn’t reflect the additional payments you made. . .
November 26th, 2009 at 11:17 am
I am wondering about the bank involved, is it Wachovia?
I have been involved in a brawl with them ever since
they took over my vintage World Savings option ARM (the good ones, pre-2003). They don’t seem to apply payments properly without a push each month.
November 26th, 2009 at 10:05 pm
I don’t necessarily agree that they are not applying the principle to the loan. I have been pre-paying my auto loan and my next due date is sometime next year, but every time I make a regular monthly payment my principle comes down by the correct amount.
You can’t be sure unless you check.
November 26th, 2009 at 10:11 pm
MITBeta is correct. The due date may be further out but effectively they are applying the payment to principal and interest. The only effective change is that the interest will accrue to cover the difference. My car loan is showing not due next until the fall 2010 but if you look at the principal and interest break out on a monthly basis (i pay about three payments a month) it is escalating the amount of principal and decreasing the interest on a monthly basis as would be expected.
I don’t believe it is legal to accept and cash a payment and not apply it to the loan i.e. hold the check.
January 18th, 2010 at 7:11 am
Well, I am purposefully doing what Merry has done in order to stay ahead of my mortgage payments. The question is, what would happen if I lost my job today? The answer is clear, my mortgage company would expect me to make my mortgage payments as scheduled. But what if it takes me several months to find a new job? They do not care!
Knowing that, I have spent over a year making early payments. My next mortgage payment is 13 months from today, and it will soon be 14 months. After I have a decent buffer to protect me in case of a layoff, I will start paying down the principal and always stay 14 months ahead. It’s what I have called a hybrid plan.