Have I Been Credited For My Mortgage Prepayment?
January 7, 2002, revised November 14, 2002, December 1, 2006
"I have read your columns about the benefits of paying early but how do I know that my extra payments are being properly credited so that I am getting the full benefit? With so much in the news about lender overcharges, how can anyone trust their lender with prepayments?" (Signed "untrusting").
There is excellent reason for your suspicions and distrust. I have never seen a statement from a lender that explains their exact procedure for crediting extra payments. That in itself should put borrowers on their guard.
Each day of delay in crediting an extra payment to the loan balance results in a transfer of one day's interest on the extra payment from the borrower to the lender. The longer the delay, the greater the interest gain to the lender, which is loss to the borrower.
The longest delay would occur if the lender placed extra payments in a special account that was held until the balance is paid down to the amount in the special account. For example, if a borrower made an extra payment of $25,000, the balance would not be affected until it had been paid down to $25,000, at which point the extra payment would be applied to pay off the mortgage.
I would view this practice as larcenous, because the lender retains the interest on $25,000 for the entire period between the date when the extra payment was made and the date the loan was paid off. While I occasionally hear stories about this practice, I have never actually seen a documented case.
Even if this extreme case doesn't exist, there is ample scope for less extreme hanky panky with extra payments. If the extra payment is included with the scheduled payment, will it be credited as of the same date as the principal portion of the scheduled payment? Or will it be pushed forward to the next month? Or perhaps to the end of the year?
If lenders were required to provide borrowers with monthly statements that detailed all transactions that affected the borrower's account, which I believe should be the law (see Should All Borrowers Receive Monthly Statements?), the problem would not exist. Many lenders don't provide such statements, however, and some that do are not complete.
A few lenders have begun to provide borrowers with access to their payment history on the internet but it will be a long time if ever before this becomes standard practice.
Meanwhile, you can keep track of your account using Excel spreadsheets I developed for just this purpose. One is for FRMs, the other for ARMs. The spreadsheets show your entire amortization schedule, with an empty column for prepayments. When you enter a prepayment , the entire schedule is recalculated on the assumption that the prepayment is credited on the same date as the scheduled payment of principal.
For example, you take out an FRM for $200,000 at 6.5% for 15 years. You enter these numbers at the top of the spreadsheet and it gives you the complete schedule, including the balance at the end of every month. It shows, for example, that after 12 months, you will have a balance of $191, 854. If you make an extra payment of $1500 in month 5, the schedule recalculates to show a balance in month 12 of $190,296. If the lender has properly credited you with the prepayment, the balance shown for month 12 on the lender’s statement should be identical.
If you enter every prepayment in the spreadsheet and save it, monitoring your lender’s bookkeeping will be a breeze.
You can monitor amortization on an ARM in much the same way using the ARM spreadsheet. In this case, you must enter not only the extra payments but also the interest rate. Beyond that, it works the same way as the FRM spreadsheet.
"I have tried to use the extra payments calculator on your web site to see when my loan will pay off, but it is for people with regular habits who pay a certain amount at regular intervals. My extra payments are scattered and for varying amounts. Can you help?"
Yes, the Excel spreadsheet I just described will take account of any number of extra payments of any amount in any month, and show you when payoff occurs. You just scroll down the worksheet until you get to a zero balance. Extending the example I gave above, the first extra payment of $1500 in month 5 results in payoff in 177 months. If I add extra payments of, say, $2200 in month 11, $1200 in month 25 and $4500 in month 39, I find that payoff occurs in 167 months.
You can access the spreadsheet here.
"I have read your columns about the benefits of paying early but how do I know that my extra payments are being properly credited so that I am getting the full benefit? With so much in the news about lender overcharges, how can anyone trust their lender with prepayments?" (Signed "untrusting").
There is excellent reason for your suspicions and distrust. I have never seen a statement from a lender that explains their exact procedure for crediting extra payments. That in itself should put borrowers on their guard.
Lenders Have a Financial Incentive to Delay Crediting Extra Payments
Each day of delay in crediting an extra payment to the loan balance results in a transfer of one day's interest on the extra payment from the borrower to the lender. The longer the delay, the greater the interest gain to the lender, which is loss to the borrower.
The longest delay would occur if the lender placed extra payments in a special account that was held until the balance is paid down to the amount in the special account. For example, if a borrower made an extra payment of $25,000, the balance would not be affected until it had been paid down to $25,000, at which point the extra payment would be applied to pay off the mortgage.
I would view this practice as larcenous, because the lender retains the interest on $25,000 for the entire period between the date when the extra payment was made and the date the loan was paid off. While I occasionally hear stories about this practice, I have never actually seen a documented case.
Even if this extreme case doesn't exist, there is ample scope for less extreme hanky panky with extra payments. If the extra payment is included with the scheduled payment, will it be credited as of the same date as the principal portion of the scheduled payment? Or will it be pushed forward to the next month? Or perhaps to the end of the year?
Protecting Yourself
If lenders were required to provide borrowers with monthly statements that detailed all transactions that affected the borrower's account, which I believe should be the law (see Should All Borrowers Receive Monthly Statements?), the problem would not exist. Many lenders don't provide such statements, however, and some that do are not complete.
A few lenders have begun to provide borrowers with access to their payment history on the internet but it will be a long time if ever before this becomes standard practice.
Meanwhile, you can keep track of your account using Excel spreadsheets I developed for just this purpose. One is for FRMs, the other for ARMs. The spreadsheets show your entire amortization schedule, with an empty column for prepayments. When you enter a prepayment , the entire schedule is recalculated on the assumption that the prepayment is credited on the same date as the scheduled payment of principal.
For example, you take out an FRM for $200,000 at 6.5% for 15 years. You enter these numbers at the top of the spreadsheet and it gives you the complete schedule, including the balance at the end of every month. It shows, for example, that after 12 months, you will have a balance of $191, 854. If you make an extra payment of $1500 in month 5, the schedule recalculates to show a balance in month 12 of $190,296. If the lender has properly credited you with the prepayment, the balance shown for month 12 on the lender’s statement should be identical.
If you enter every prepayment in the spreadsheet and save it, monitoring your lender’s bookkeeping will be a breeze.
You can monitor amortization on an ARM in much the same way using the ARM spreadsheet. In this case, you must enter not only the extra payments but also the interest rate. Beyond that, it works the same way as the FRM spreadsheet.
"I have tried to use the extra payments calculator on your web site to see when my loan will pay off, but it is for people with regular habits who pay a certain amount at regular intervals. My extra payments are scattered and for varying amounts. Can you help?"
Yes, the Excel spreadsheet I just described will take account of any number of extra payments of any amount in any month, and show you when payoff occurs. You just scroll down the worksheet until you get to a zero balance. Extending the example I gave above, the first extra payment of $1500 in month 5 results in payoff in 177 months. If I add extra payments of, say, $2200 in month 11, $1200 in month 25 and $4500 in month 39, I find that payoff occurs in 167 months.
You can access the spreadsheet here.