Mortgage prepayment question

[MoobyTheGoldenCalf]

My head is fuzzy. Can someone answer the following hypothetical scenario for me?

Say I have a mortgage and it is January 1. I pay ALL my payments for the calendar year on January 1. So I make February's, March's, etc... all on Jan 1. I just pay the statement amount, no extra principal and then I don't make any more payments for the rest of the year.

Would doing that lower my total interest due on the loan at all? Or would that have the same net effect as just making the payments on the regular schedule?

 

[rcpratt]

Yes, it would lower your interest and allow you to pay off the loan sooner. If you didn't make payments for the rest of the year, it would have a modest impact depending on your rate. If you continued to make payments for the rest of the year, it would have a huge impact.

 

[TwiceOver]

I believe it depends on how your loan is structured. On mine, the interest would be reduced.

 

[mnewsham]

How would you do that? From what I know when you over pay during the month they automatically take it off the principle. Unless you are writing 12 checks that are dated like 1/1/2012, 2/1/2012, 3/1/2012...etc I would just assume they would take it from your principle, and expect your payment next month for the minimum. Could be wrong though

 

[TwiceOver]

How would you do that? From what I know when you over pay during the month they automatically take it off the principle. Unless you are writing 12 checks that are dated like 1/1/2012, 2/1/2012, 3/1/2012...etc I would just assume they would take it from your principle, and expect your payment next month for the minimum. Could be wrong though

Again, depends on your loan. When I make a loan payment of my due amount or more, it automatically moves my payment to the next date, no matter how early I pay.

 

[MoobyTheGoldenCalf]

How would you do that? From what I know when you over pay during the month they automatically take it off the principle. Unless you are writing 12 checks that are dated like 1/1/2012, 2/1/2012, 3/1/2012...etc I would just assume they would take it from your principle, and expect your payment next month for the minimum. Could be wrong though

I have GMAC, you can schedule payments in advance like that online. I've got a bunch of cash sitting earning 1% in a savings account now. Since interest rates aren't going anywhere anytime soon, I was thinking about just paying my mortgage in advance like that and seeing if I could get some savings there.

 

[SunnyD]

I believe it depends on how your loan is structured. On mine, the interest would be reduced.

This.

My payment statement comes specifically with lines where I can enter what amount of my OVERPAYMENT is applied to what. If I make an overpayment without specifying how to apply it, they will automatically apply it to the interest first.

One thing to keep in mind though, if I overpay, for example your scenario, an entire year on one statement... I will STILL get a statement the next month expecting payment for that month. If I don't pay it, I would end up in default.

(That's the part that confuses me about your scenario, you pay a year up front... but then are you still paying each month or not?)

 

[mnewsham]

I have GMAC, you can schedule payments in advance like that online. I've got a bunch of cash sitting earning 1% in a savings account now. Since interest rates aren't going anywhere anytime soon, I was thinking about just paying my mortgage in advance like that and seeing if I could get some savings there.

If you can take your savings and apply it to the principle you will probably save more in the long run.

 

[MoobyTheGoldenCalf]

This.

My payment statement comes specifically with lines where I can enter what amount of my OVERPAYMENT is applied to what. If I make an overpayment without specifying how to apply it, they will automatically apply it to the interest first.

One thing to keep in mind though, if I overpay, for example your scenario, an entire year on one statement... I will STILL get a statement the next month expecting payment for that month. If I don't pay it, I would end up in default.

(That's the part that confuses me about your scenario, you pay a year up front... but then are you still paying each month or not?)

I'm not talking about making a years worth of payments on one statement, I'm saying making 12 payments (1 for each month), but all at the same time. So for example, if I did this now, my next payment due wouldn't be until August 2012.

 

[rcpratt]

I'm not talking about making a years worth of payments on one statement, I'm saying making 12 payments (1 for each month), but all at the same time. So for example, if I did this now, my next payment due wouldn't be until August 2012.

If you can do that then yes, you would save a modest amount. If you gave us the details of the mortgage we could tell you how much.

 

[SunnyD]

I'm not talking about making a years worth of payments on one statement, I'm saying making 12 payments (1 for each month), but all at the same time. So for example, if I did this now, my next payment due wouldn't be until August 2012.

You'd better ask your lender if you can do that. Like I said, the way mine is set up... ANY overpayment on a given month is applied to the account as a one time overpayment. I will still get a statement the next month expecting payment. AFAIK, most lenders will do this - any overpayment applies to the END of the loan first.

 

[rcpratt]

You'd better ask your lender if you can do that. Like I said, the way mine is set up... ANY overpayment on a given month is applied to the account as a one time overpayment. I will still get a statement the next month expecting payment. AFAIK, most lenders will do this - any overpayment applies to the END of the loan first.

Wouldn't it be more effective for the consumer to apply the overpayment to the principal?

 

[MoobyTheGoldenCalf]

Wouldn't it be more effective for the consumer to apply the overpayment to the principal?

Sure, but this is my emergency fund. Like I said, sitting there doing nothing, but earning 1%. If I lost my job or something I would use this cash to pay my mortgage. So if the mortgage is already paid off for the year, that's what I would have used this emergency cash for anyway.

If I just prepay principal, I've still got to make my mortage payment next month.

 

[kranky]

You cannot skip payments by paying extra. You must make a payment every month. When you pay extra, it does reduce the percentage of your next payment that goes to interest, so it does save you money, and you will pay off your mortgage sooner.

The extra amount you pay just "moves you ahead" on the amortization schedule. Here's an imperfect example to illustrate. Payments are $1000/month. I'm making up round numbers just to show the concept.

Payment 30 includes $300 in principal and $700 in interest.
Payment 31 includes $310 in principal and $690 in interest.
Payment 32 includes $320 in principal and $680 in interest.
Payment 33 includes $330 in principal and $670 in interest.

Each payment totals $1000, but each month the split between principal and interest changes slightly to include more towards principal. Now let's say this month payment 30 is due.

Instead of paying $1000, you send in $1960. The extra $960 goes towards the principal. You just jumped ahead 3 payments on your mortgage, because $960 is the amount due towards principal for the next 3 payments.

You don't have to make it come out even like my example but the point is any extra amount you pay goes towards principal, and moves you ahead on the amortization schedule even if it's only by a little.

Look at an amortization schedule for a 30-year mortgage, and see how little goes towards principal for the payments early in the mortgage. You might be able to take a whole year off your mortgage by paying just a little extra.

But again, you must send in a full payment every month, no matter how much extra you might have paid previously.

 

[Scarpozzi]

I had a boat loan years ago that I was paying off early. I had paid 15 months in advance and could have stopped paying on it anytime to let the interest "catch back up" with my original amortization schedule.

I've seen it done 2/3 different ways. They're all basically the same, but have different requirements of the payee that's typically all based on how their computer systems work. By law, they all have to process interest the same basic way....it's just about the details of how they apply the payment and either allow you to skip payments or simply shorten the loan by reducing the number of payments.

For example, your mortgage payment is $1000/month
1. You pay $3000. $1000 is applied to your current month. $2000 is applied directly to your principal, lowering the interest you'll pay and reducing the number of payments it will take to pay off the mortgage....but you still have to pay $1000 the following month.

2. You pay $3000. The bank will apply $1000 to your current month, and pay the remaining $2000 to future months, thus your next mortgage due date will be 3 months into the future.... The only catch here is that if you don't make the following month's payment, despite not owing anything, you will acrue interest and defeat the purpose of paying a larger lump-sum.

3. This is the same as 2....the only difference is that rather than paying 3 times the amount, you pay an odd number like $2999. Rather than processing the payment as 3 months, they will apply it to the principal and still require you to make the following month's payment.

Note...be aware that some mortgage lenders will penalize you for early loan repayment. Make sure you read up...I've only dealt with my credit union and they've been more than accomodating with everything.

 

[mnewsham]

Sure, but this is my emergency fund. Like I said, sitting there doing nothing, but earning 1%. If I lost my job or something I would use this cash to pay my mortgage. So if the mortgage is already paid off for the year, that's what I would have used this emergency cash for anyway.

If I just prepay principal, I've still got to make my mortage payment next month.

I would put 1/2 of your "emergency" fund to your principle then keep making monthly payments (and rebuild your emergency fund for next year)

 

[MoobyTheGoldenCalf]

That's not what I'm saying. Let me rephrase the question. I'm going old school here.

Say I have a mortgage payment book, with 360 payment slips in them. Each one marked for each month of my mortgage. I take 12 of them, write 12 checks, put them in 12 envelopes and mail them in all on Jan 1. My next payment is not now due for another year. Will this save me any interest as opposed to just making the payments on time?

 

[mnewsham]

That's not what I'm saying. Let me rephrase the question. I'm going old school here.

Say I have a mortgage payment book, with 360 payment slips in them. Each one marked for each month of my mortgage. I take 12 of them, write 12 checks, put them in 12 envelopes and mail them in all on Jan 1. My next payment is not now due for another year. Will this save me any interested as opposed to just making the payments on time?

It shouldnt no, it will just allow you to not make payments for 12 months, it would probably make you lose money (as you dont get your 1% from the bank) it would be the same as paying like you are now you just lose your money at once instead of slowly. AFAIK anyway.

 

[the DRIZZLE]

It shouldnt no, it will just allow you to not make payments for 12 months, it would probably make you lose money (as you dont get your 1% from the bank) it would be the same as paying like you are now you just lose your money at once instead of slowly. AFAIK anyway.

This is my understanding as well. As far as I know this is no such thing as an "early" payment on a mortgage. You can make extra payments toward the principle which will reduce future interest, but I don't believe you get any credit for making your regular payments early.

 

[waffleironhead]

That's not what I'm saying. Let me rephrase the question. I'm going old school here.

Say I have a mortgage payment book, with 360 payment slips in them. Each one marked for each month of my mortgage. I take 12 of them, write 12 checks, put them in 12 envelopes and mail them in all on Jan 1. My next payment is not now due for another year. Will this save me any interest as opposed to just making the payments on time?

No, they would probably still expect another payment in February.

 

[mvbighead]

I would put 1/2 of your "emergency" fund to your principle then keep making monthly payments (and rebuild your emergency fund for next year)

I would say this also.

It also might be feasible, given the size of your current emergency fund, to simply pay more in principle each month. Anything extra (as has been said several times now) goes straight against principle, which reduces the length of the loan, as well as the amount of interest you'll end up paying on the loan.

 

[Thump553]

Read your mortgage note and get back to us. You cannot pay a whole year's payments on January 1st (unless that pays the loan off in full). What you woule end up doing is paying the P&I due January 1st and a boatload of additional principal (if you so designated it, otherwise some lenders will apply your extra payment to the escrow account, the worst possible result).

You will still have a regular mortgage payment due February 1st and each month thereafter. A huge payment in January doesn't otherwise alter the obligations under your Note.

Your 12 checks/12 envelopes system might trick the bank into depositing one check at a time as they become due, which would have absolutely no prepayement effect.

 

[SunnyD]

Wouldn't it be more effective for the consumer to apply the overpayment to the principal?

Of course it would be... but remember, the lender is hoping the consumer is dumb!

That's not what I'm saying. Let me rephrase the question. I'm going old school here.

Say I have a mortgage payment book, with 360 payment slips in them. Each one marked for each month of my mortgage. I take 12 of them, write 12 checks, put them in 12 envelopes and mail them in all on Jan 1. My next payment is not now due for another year. Will this save me any interest as opposed to just making the payments on time?

Again, YOU HAVE TO CONSULT YOUR LENDER. Most "prepayments" simply slide your end date forward. Regardless of the dates listed on each payment slip, if you prepay, odds are your lender will just adjust the loan with respect to the prepayment sliding the ending date up and STILL EXPECTING payment the following month.

Please, for the love of everything sacred, TALK TO YOUR LENDER. Last thing I'd want is to see you posting 3 months from now that you're in foreclosure because of ATOT's advice (or your ignoring it).

The term "prepayment" in terms of loans generally means to shorten the duration of the loan, not "prepay" chunks of it at a time.

Seriously dude... talk to your lender, not us. (That and each state has different laws regarding prepayment as well)

 

[Drekce]

Mortgages usually work the way everyone is describing here, but my car loan doesn't. My loan is about $400/month (5 years), but I've been paying $1,000/month since I got it about a year ago. My last statement said my next payment isn't due until January of 2013.

 

[JTsyo]

Whenever I paid my mortgage, my bank would send me the next statement. I didn't catch on right away and now I'm 2 months ahead on payments. I get a statement and the next due date is Nov. So I guess it'll depend on your lender.