This is the second of a series on questions about mortgage
repayment. The first article looked at mortgage repayment as
a type of investment. This one is focused on payment
mechanics.
Q: Will I save money if I make my
regular monthly payment early?
A: No, paying early merely allows the firm servicing your
loan to earn interest on your money until the first of the
month when your payment is due. On a standard mortgage, the
scheduled payment is due the first of the month, but there
is a grace period of 10 to 15 days during which the payment
can be made and will be credited as if it were paid on the
first. If payment is received after the grace period, a late
fee is imposed, but payments received before the due date
are not rewarded for paying early.
An exception is the simple interest mortgage (SIM), on which
interest accrues daily. On these mortgages, every day of
delay in making the payment increases the interest cost, and
the earlier you pay, the more interest you save.
Q: How do I know if my mortgage is
simple interest?
A: Your note should say that interest accrues daily, but it
might not. A sure sign is that the monthly payment on a SIM
varies month to month, so if your monthly payment is always
the same, you do not have a SIM.
Q: What is the best time of the
month to make an extra payment?
A: It is the last day of the month for which the lender will
apply the payment to the current balance. If you include the
extra payment with your scheduled payment and pay within the
grace period, the extra payment will be applied to the
current balance. If you make the extra payment after the
grace period, it might be applied to the current balance, or
it might not be credited until the following month,
depending on the systems/policies of the servicer. You
should find out where the servicer’s cutoff is for crediting
payments in the current month.
Q: If I make a large extra
payment, will my future scheduled payments be lower?
A: On a fixed-rate mortgage, the scheduled payment is not
affected by the extra payment. You merely pay down the
balance faster. However, at your request and for a fee, some
servicers will reduce the payment to the amount that will
amortize over the remaining term. If you want to do this,
arrange it beforehand.
On an adjustable rate mortgage, the scheduled payment
remains the same until the next rate adjustment. At that
point, the payment is recalculated based on the reduced
balance, the new rate and the original term. So unless it is
offset by a rate increase, the payment will drop.
Q: What is the difference between an extra payment and an
advance payment?
A: An extra payment reduces the loan balance, while an
advance payment is the scheduled payment made before the due
date. It is an interest-free loan to the servicing agent for
the period until the payment comes due. Advance payments
serve no purpose for borrower s except for the possible
peace of mind that stems from knowing that they are
ahead of the game.
Q: How does the servicer distinguish an advance payment from
an extra payment?
A: The borrower’s actions usually indicate the intention. If
the borrower remits a check that is $100 larger than the
scheduled payment, for example, the servicer will interpret
the $100 as an extra payment and credit it accordingly.
The one ambiguous situation would be where the borrower pays
an amount that is an exact multiple of the scheduled
payment, which could be intended as several scheduled
payments, or as one scheduled payment with a substantial
extra payment. It is up to borrowers to make their
intentions clear.
Q: Aren’t advance payments necessary if you plan to be out
of touch for a long period?
A: No. I spent a year traveling and never made any advance
payments on my mortgage. Before I left, I gave my mortgage
lender 12 checks dated on the first day of 12 consecutive
months. These were not advance payments because the checks
would not clear before those dates.
Q: How do I know that the lender has credited my account
promptly for my extra payment?
A: You should be able to tell from
monthly statements received from the lender that show all
transactions during the month by date. Such statements
should be mandatory but they aren’t. Many borrowers receive
only an end-of-year statement. The best approach for them is
to keep track of their account using Excel spreadsheets I
developed for this purpose, then match the results against
the end-of-year statement received from the lender.
The spreadsheets are
Extra Payments
on Monthly Payment Fixed-Rate Mortgages,
and
Extra Payments on
Adjustable Rate Mortgages.
Q: Can I pay off an adjustable rate mortgage early?
It is difficult but doable if you
know how. The reason it is difficult is that the extra
principal payments designed to shorten the term reduce the
scheduled monthly payment at each rate adjustment, because
the new payment is calculated to pay off over the original
term. To offset the decline in the scheduled payment, the
borrower must increase the extra payment at every rate
adjustment date. This is a pain, but I now have a calculator
that eases the pain substantially. This is
Extra Payments Required to Pay Off
By a Certain Period.
The procedure is described in
Using a Calculator to Prepay an
ARM.
