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Making Mortgage Prepayments

Written by Nickel - 22 Comments

I 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 - 22 Comments
Filed under: Debt Reduction, Mortgages

About the author: 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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22 Responses to “Making Mortgage Prepayments”

  1. 1
    TTFK Says:

    Some servicers such as CitiMortgage also have a line item where you can specify an additional payment made to principal.

  2. 2
    Daniel Says:

    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.

  3. 3
    Kar J Says:

    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.

  4. 4
    Evan Says:

    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.

  5. 5
    John DeFlumeri jr Says:

    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

  6. 6
    Financial Samurai Says:

    I’d pay once a year, one junk to principal only. It’s easier and more efficient.

  7. 7
    Don@Moneyreasons.com Says:

    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?

  8. 8
    Jordan Says:

    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.

  9. 9
    JerryB Says:

    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.

  10. 10
    EZ Says:

    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.

  11. 11
    Lyman Says:

    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. . .

  12. 12
    DaveW Says:

    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.

  13. 13
    MITBeta @ Don't Feed the Alligators Says:

    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.

  14. 14
    Andy Says:

    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.

  15. 15
    CharlieBoy Says:

    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.

  16. 16
    Thomas Gerling Says:

    CharlieBoy,

    I was 17 months ahead on our mortgage when we paid it off this month. At first we were sending in principal only payments, but when the job market went south, and I could have lost my about 18 months ago, I began making extra payments each month. It did cost us $1,148.77 in interest paid, and Wells Fargo only returned about $400 in prepaid interest when the loan was paid off. But, what if I lost my job and couldn’t make payments for a year? That was the price for being able to sleep at night.

  17. 17
    CharlieBoy Says:

    Thomas, I am willing to lose some money to interest too in order to pay ahead for over a year for protection. In two weeks, I will be paying my mortgage from May of 2011. In this economy, most people underestimate how long it is might take us to find another job. Peace of mind, that’s worth it.

  18. 18
    Thomas Gerling Says:

    Compared to the cost of life, medical and auto insurance, it’s great to know that if you loose your job (Unemployment is 12.5% in California), you won’t loose your house. At least I can collect cans to make money for food if that happens.

  19. 19
    CharlieBoy Says:

    Thomas, also, I store dry grains in my basement. They are pre-packaged for storage. The expiration date of my rice and beans is in 30 years. I am working on storing enough to survive a year. Rice and beans can sustain life.

  20. 20
    Ken Says:

    A newbie to this post- Suggestions will be greatly appreciated.
    Bank of America is giving me a really hard time. Every month, from past few months, I have been making my regular mortgage payment. In addition, I have been sending them an additional check of exact dollar amount of the next principal and requesting them to apply this additional principal prepayment to THAT month. I have also been including a cover letter to explain this. But everytime they have applied this additional principal payment to the end of the mortgage.
    I have spent hours over the phone with their mortgage department trying to explain this but they just don’t understand (or may be they dont want to understand) and they keep on repeating this same mistake.
    Have you dealt with Bank of America for a similar scenario?

  21. 21
    Samantha Says:

    I have an issue with Bank of America where they took a portion of my regular payment – $216.56 and applied it to the next month’s payment. Why I have no clue. My regular payment is $1891.72 and I also pay $108.28 in extra pincipal. By them taking the $216.56 and applying to the next month, the next month’s regular payment is 1675.16. I just discovered this when Green Tree took over and they sent me a statement for June, 2011 and my regular payment due shows as $1675.16. I told them I have been paying $1891.72 for the past 8 years and this is the regular payment. Green Tree says I have to dispute how my payment is being applied and they have to work this out with Bank of America. These people at Bank of America are unbelievably incompetent. I hope this turns out ok.

    Bank of America took over my mortgage after they bought out LaSalle Bank. Bank of America took over in November, 2008. The first payment I made to Bank of America was for November, 2008 and I paid it in person at their branch. They took the $1891.72 and split it into 3 payments and applied to November, December, and January, 2009. I almost lost it with them. They fixed it and all was good until September, 2009 when they decided my regular payment was $1675.16 and the $216.56 will be applied to the following month.

    Unbelievable the morons that this bank employs.

    Samantha

  22. 22
    Monica Says:

    Ken – or anyone else trying to get Bank of America to apply extra principal payments to the next month’s principal payment and not apply it to the back end. I am trying to get them to do this, too, and am not having any luck. Any advice from someone who’s had a similar experience and was able to resolve it would be appreciated.

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