Help with Mortgage-speak!

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moneypenny02
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Joined: Thu Jan 03, 2013 3:14 pm

Help with Mortgage-speak!

Post by moneypenny02 »

Hi,
I am trying to explain something to my loan servicer, but I am having a hard time getting my question across or really understanding whether he is answering me. Hopefully someone here can give me the correct terms to use to communicate with him properly.

Background: We have already closed on our mortgage and we are about 3 months into paying. This is my first mortgage, but I have a LOT of experience with student loans. With my student loan, for example, $500 is due the 1st of every month, which includes principal and interest on my 30-year payment schedule. If I pay $500 on January 25th in advance of my February due date, then I have paid all of the interest for that month, as well as a little bit to the principal. Assuming my payment gets applied immediately, interest starts to accrue again on January 26th. If I make a payment on January 26th for $500 and select "apply this to my next payment", then the result of that is that it goes about 99% to principal, and only a little bit to whatever interest has accrued btwn my 1st and second payment. I do this every month, so I keep getting more and more payments "ahead" of schedule. I have used this method instead of just adding a $500 principal payment so that I can pay down my principle faster AND give me a cushion so that if something happens in the future and I cannot afford to make the payments. (The next "due" date on my loan isn't until Oct. 2014, but I still pay each month--twice.)

Now for my mortgage loan. It is a 30 year fixed rate mortgage, with no prepayment penalty. Let's say it is $2000/mo, and the most recent payment includes $1500 to interest and $500 to principal. It is due the 1st of each month. I just made a payment of $2000 for the payment due March 1st. The next day I made another $2000 payment toward my payment due April 1st. I believe this should work the same way as my student loan--because I JUST made a payment, there should be no more outstanding interest, and the entire payment, although made toward the April 1st loan payment, should end up going almost completely to the principal. The loan person that I spoke with not only did not agree, he couldn't even understand how it would work that an entire payment would get credited to princpal. He kept saying something over and over about the interest being paid in arrears, but I don't think he really understood the math behind anything that he was saying. I checked and this payment was allocated, lets say $1490 to interest and $510 to principal--so basically the same as if I had made that payment on March 31st.

Can someone please explain to me in technical terms why the student loan works that way (e.g. amortization, compounding, etc.), and if there is any reason that my mortgage loan should not? I don't even know the right questions to ask, so I don't know how to make my case, or if I should accept that they are correct.

Thank you!
dailybagel
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Re: Help with Mortgage-speak!

Post by dailybagel »

Do you want to make an early payment so that you can skip the next month's payment? Or do you want to make a payment that reduces principle?

Asking how you can make a payment "towards principle" is a standard question. But if you make such a payment, your regular payment will be due as usual in the regular amount.
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grabiner
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Re: Help with Mortgage-speak!

Post by grabiner »

Mortgage interest normally accrues monthly, not daily; on March 1, you pay the interest that accrued during February. And mortgage payments are credited for the month, regardless of the actual day. If you pay your March 1 payment on March 3 (which is when it is due this year since March 1 is a Saturday), you don't owe an extra two days' interest; if you pay it on February 26, you don't save three days' interest.

There are two ways to prepay a mortgage. You can make a payment in advance. If you make a double payment of this type on March 1, this will cover your March and April payments, but the payment won't be applied to your balance until April 1. Thus, you won't owe a payment in April, but your mortgage balance in April will be the same as if you had made single payments.

Alternatively, you can make a payment and apply it to the principal. If you do this, you will still have the same amount due every month (on a fixed-rate loan, or on an adjustable-rate loan until the next adjustment), but your reduced principal will accrue less interest, so more of your future payments will go to principal and you will pay off the loan faster. This is probably what you want to do, so you need to specify this to the servicer, "Here is an extra payment of $2000; please apply this to the mortgage principal."
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Re: Help with Mortgage-speak!

Post by Novine »

I can't speak to how student loans work but I'm not aware of any way to "pay ahead" on the mortgage such that you could skip a payment. As Grabiner noted, you can pay extra towards your principal but you'll still have to make a payment every month until you pay off your loan.
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moneypenny02
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Re: Help with Mortgage-speak!

Post by moneypenny02 »

Thank you for the responses.

Re: whether I wanted to pay down principal faster or be able to skip a payment--Ideally I wanted to do both. In the timing of my student loans, I am able to do both. I am trying to figure out whether I could do the same with my mortgage loan. Also, note, I am not trying to "skip" a payment. I wanted to pay ahead just in case something happens and I can't pay my bill that month--I will keep making a payment each month (i.e. I will pay the bill that is currently listed as due on May 1st by March 31st). With the student loan payments I get both benefits b/c I keep making double payments, and the second payment goes to principal but also gives me a "built in deferral" if I ever can't afford to pay. I was hoping to do the same with my mortgage (as finances allow).

So, if the mortgage accrues monthly, what interest is accruing between Feb. 24th and Feb. 25th? I understand that making the payment 3 days early will not reduce my interest payment...but what about 33 days early? If my April 1st bill pays the interest that accrued in March, if I make my April payment NOW, then there was no interest to accrue in March. Even if it was daily, the only interest that could have accrued between my two payments was on Feb. 25th -- and this amount is already included in my March 1st bill.

It seems like what you are saying is that, basically, the servicer just holds my loan payment--made 33 days early and when there should be no outstanding interest on the loan b/c it was just paid--and applies it on the due date of the loan. Putting aside whether that seems legal, it also seems wrong (wrong with respect to what the servicer says they are doing), b/c the FAQs on my loan servicer's page specifically says that you cannot set up to do bi-weekly payments, but you can pay an additional payment in the year, and it will have the same result. If they are just holding that extra payment until it is actually due, then it doesn't seem to achieve any result whatsoever.
DSInvestor
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Re: Help with Mortgage-speak!

Post by DSInvestor »

If you want to pay extra principal with any payment, just add that amount to the payment. If paying by check, the payment slip should have a box for extra principal. If paying by autodebit, you can alter the automatic transaction to include some extra principal.

Do you have an emergency cash reserve? If not, you should establish one so you can have a cushion in case of a dip in your cash flow. Rather than pay early, keep the money in cash reserves and pay on time. If you have reserve for 3-6 months expenses, you can handle an emergency water heater heater and failed car transmission and still make your mortgage payment. If there is no cash reserve, little problems can be big problems if you miss a mortgage payment. With a cash reserve, you little problems are just little problems.
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moneypenny02
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Re: Help with Mortgage-speak!

Post by moneypenny02 »

DSInvestor wrote:If you want to pay extra principal with any payment, just add that amount to the payment. If paying by check, the payment slip should have a box for extra principal. If paying by autodebit, you can alter the automatic transaction to include some extra principal.

Do you have an emergency cash reserve? If not, you should establish one so you can have a cushion in case of a dip in your cash flow. This way you can handle an emergency water heater heater and failed car transmission and still make your mortgage payment.

Thanks, but as I said I was ideally trying to accomplish both. I pay online and you can choose to allocate money to additional principal, or to the next payment. I chose the latter. (We do pay some additional to principal monthly, but it is not the same amount as our full payment.) We also do have an emergency reserve--both a normal savings for incidentals, but also catastrophic, for instance if one of us lost our jobs. I am only concerned with not making payments if something like the latter happened or some other serious accident, etc., finances are not so bad that we are one blown water heater away from a missed mortgage payment.

The point was that, with my student loan, I can pay "ahead" and get principal reduction. If this is possible for our mortgage as well, then it makes more sense to use some of the "emergency funds" that are there to pay off the mortgage in an emergency to pay ahead NOW, so that we get the same cushion that we would need if something happens (because until then we would still make a payment monthly, even though it is not officially "due" for a few months out) AND we get the benefit of principal reduction because at the time that we made the payment (equal to one month's principal and interest) there was no outstanding interest that had yet accrued.

Perhaps there is some way that a mortgage loan is structured that differs from a student loan that would explain why I can accomplish this with one and not the other, but no one has yet explained it. If I have 4.5% interest/yr, compounded monthly, once my March 1st payment is made that covered all interest--including 3 days that had not yet accrued--for February, then what interest is being paid when I make my payment for Apr. 1st that next day? Interest cannot be paid both in arrears AND prospectively.
porcupine
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Re: Help with Mortgage-speak!

Post by porcupine »

moneypenny02 wrote:Hi,
I am trying to explain something to my loan servicer, but I am having a hard time getting my question across or really understanding whether he is answering me. Hopefully someone here can give me the correct terms to use to communicate with him properly.

Background: We have already closed on our mortgage and we are about 3 months into paying. This is my first mortgage, but I have a LOT of experience with student loans. With my student loan, for example, $500 is due the 1st of every month, which includes principal and interest on my 30-year payment schedule. If I pay $500 on January 25th in advance of my February due date, then I have paid all of the interest for that month, as well as a little bit to the principal. Assuming my payment gets applied immediately, interest starts to accrue again on January 26th. If I make a payment on January 26th for $500 and select "apply this to my next payment", then the result of that is that it goes about 99% to principal, and only a little bit to whatever interest has accrued btwn my 1st and second payment. I do this every month, so I keep getting more and more payments "ahead" of schedule. I have used this method instead of just adding a $500 principal payment so that I can pay down my principle faster AND give me a cushion so that if something happens in the future and I cannot afford to make the payments. (The next "due" date on my loan isn't until Oct. 2014, but I still pay each month--twice.)

Now for my mortgage loan. It is a 30 year fixed rate mortgage, with no prepayment penalty. Let's say it is $2000/mo, and the most recent payment includes $1500 to interest and $500 to principal. It is due the 1st of each month. I just made a payment of $2000 for the payment due March 1st. The next day I made another $2000 payment toward my payment due April 1st. I believe this should work the same way as my student loan--because I JUST made a payment, there should be no more outstanding interest, and the entire payment, although made toward the April 1st loan payment, should end up going almost completely to the principal. The loan person that I spoke with not only did not agree, he couldn't even understand how it would work that an entire payment would get credited to princpal. He kept saying something over and over about the interest being paid in arrears, but I don't think he really understood the math behind anything that he was saying. I checked and this payment was allocated, lets say $1490 to interest and $510 to principal--so basically the same as if I had made that payment on March 31st.

Can someone please explain to me in technical terms why the student loan works that way (e.g. amortization, compounding, etc.), and if there is any reason that my mortgage loan should not? I don't even know the right questions to ask, so I don't know how to make my case, or if I should accept that they are correct.

Thank you!
Hello Ms. Moneypenny:

I'm pine, Porcu pine. Maybe I can help!

A while back, we had a whole long discussion on simple interest vs. compound interest. You might want to read that or you might not want to read that, as it might confuse you even more! :oops:

The gist of all that is that you have what is a normal fixed-term loan mortgage product, which is a compound interest loan. When you make your first payment which, say, is due on 1/1, you have actually paid the interest that added up from the time you signed the loan paperwork and got the money credited to the time when the monthly mortgage payment is due - in this case 1/1. The cycle starts all over again and on 2/1 you pay the interest that added up during January (as part of the monthly mortgage payment).

For the rest of the discussion here, let's say that the payments are due on the first of the month. Also, let's assume that no penalties or late fees are tacked on.

In compound interest loans, the interest is based upon a month's duration of outstanding principal (they use either 1/12 or 30/365 to calculate the interest); there is a concept of a grace period, i.e., you might get away making a payment on 2/14 even if it is due on 2/1. You would still be paying the same interest that you would've paid on 2/1 and the rest will go to the principal. And on 3/1, you will be charged interest only on the principal that is left over on 2/14 ... but for the whole month's duration. The only way you can make everything count against the principal is by making a payment and specifically notifying the loan servicer that it is for principal only. However, making a principal only payment does not change the fact that you still owe the next monthly mortgage payment on the 1st of the next month.

On the other hand, there is a simple interest loan, in which case also you are paying interest on the outstanding principal and that is also accrued until paid. However, there is a (key) difference - in simple interest loans, each day counts. If you make the payment on 1/30 instead of 2/1, you are charged interest for 29 days (assuming that the previous payment was on 1/1) and the remaining is paid against the loan principal. Also, if you make two payments on consecutive days, say 2/1 and 2/2, then the first payment will meet your obligation towards the payment due on 2/1 and the second payment will meet your obligation towards the payment due on 3/1. Besides, only one day's worth of interest will be deducted from the payment made on 2/2 and the rest will go towards the principal. Your next payment will then be due on 4/1 but there is a twist. If you pay it on 4/1, you will be paying interest from 2/2 through 4/1, i.e., nearly 60 days!

There are some mortgage products out there that are simple interest loans - for instance, my Home Equity Loan (HEL) with Penfed is one. But most of the mortgage products are fixed term compound interest loans.

- Porcupine
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tfb
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Re: Help with Mortgage-speak!

Post by tfb »

moneypenny02 wrote:Re: whether I wanted to pay down principal faster or be able to skip a payment--Ideally I wanted to do both. In the timing of my student loans, I am able to do both. I am trying to figure out whether I could do the same with my mortgage loan.
You can't do both with your mortgage. If you apply your payment toward principal, it gets applied right away, but you don't get to push back the next payment due date. If you apply your payment toward next payment, it will be held in cash earning nothing, but you do push back the next payment due date. This is because what grabiner explained:
grabiner wrote:Mortgage interest normally accrues monthly, not daily
When you read that "you can pay an additional payment in the year, and it will have the same result [as biweekly payments]" it's assuming the additional payment is marked as "apply to principal" which doesn't change any payment due date.
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moneypenny02
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Re: Help with Mortgage-speak!

Post by moneypenny02 »


The gist of all that is that you have what is a normal fixed-term loan mortgage product, which is a compound interest loan. When you make your first payment which, say, is due on 1/1, you have actually paid the interest that added up from the time you signed the loan paperwork and got the money credited to the time when the monthly mortgage payment is due - in this case 1/1. The cycle starts all over again and on 2/1 you pay the interest that added up during January (as part of the monthly mortgage payment).

For the rest of the discussion here, let's say that the payments are due on the first of the month. Also, let's assume that no penalties or late fees are tacked on.

In compound interest loans, the interest is based upon a month's duration of outstanding principal (they use either 1/12 or 30/365 to calculate the interest); there is a concept of a grace period, i.e., you might get away making a payment on 2/14 even if it is due on 2/1. You would still be paying the same interest that you would've paid on 2/1 and the rest will go to the principal. And on 3/1, you will be charged interest only on the principal that is left over on 2/14 ... but for the whole month's duration. The only way you can make everything count against the principal is by making a payment and specifically notifying the loan servicer that it is for principal only. However, making a principal only payment does not change the fact that you still owe the next monthly mortgage payment on the 1st of the next month.

On the other hand, there is a simple interest loan, in which case also you are paying interest on the outstanding principal and that is also accrued until paid. However, there is a (key) difference - in simple interest loans, each day counts. If you make the payment on 1/30 instead of 2/1, you are charged interest for 29 days (assuming that the previous payment was on 1/1) and the remaining is paid against the loan principal. Also, if you make two payments on consecutive days, say 2/1 and 2/2, then the first payment will meet your obligation towards the payment due on 2/1 and the second payment will meet your obligation towards the payment due on 3/1. Besides, only one day's worth of interest will be deducted from the payment made on 2/2 and the rest will go towards the principal. Your next payment will then be due on 4/1 but there is a twist. If you pay it on 4/1, you will be paying interest from 2/2 through 4/1, i.e., nearly 60 days!

There are some mortgage products out there that are simple interest loans - for instance, my Home Equity Loan (HEL) with Penfed is one. But most of the mortgage products are fixed term compound interest loans.

- Porcupine
Thank you very much for the explanation! I think I am understanding, but there is one thing that still does not make sense to me. In my case, I paid the loan due on 3/1 and the payment due on 4/1 on 2/24 and 2/25 respectively. I understand that the entire month's interest is due (essentially) at the start of the month (and maybe even 14 days into the next). I don't understand how March's interest could have been triggered at all, unless it is essentially compounding for an entire month each time I make a payment--even if the month has not yet begun. I could understand if I waited until 3/1 to make the 4/1 payment, but I don't understand how it is compounding OVER a month in advance. So, on 2/25 I am being charged for the interest from 3/1-3/31? The only way this make sense to me is if, as TFB explained, the servicer just holds onto the payment for the entire month and then applies it on the actual due date. If this is the case, is there anyway that I can request them to apply it immediately (kind of like you request them to apply to principal, or to escrow, or otherwise)?
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moneypenny02
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Re: Help with Mortgage-speak!

Post by moneypenny02 »

moneypenny02 wrote:

The gist of all that is that you have what is a normal fixed-term loan mortgage product, which is a compound interest loan. When you make your first payment which, say, is due on 1/1, you have actually paid the interest that added up from the time you signed the loan paperwork and got the money credited to the time when the monthly mortgage payment is due - in this case 1/1. The cycle starts all over again and on 2/1 you pay the interest that added up during January (as part of the monthly mortgage payment).

For the rest of the discussion here, let's say that the payments are due on the first of the month. Also, let's assume that no penalties or late fees are tacked on.

In compound interest loans, the interest is based upon a month's duration of outstanding principal (they use either 1/12 or 30/365 to calculate the interest); there is a concept of a grace period, i.e., you might get away making a payment on 2/14 even if it is due on 2/1. You would still be paying the same interest that you would've paid on 2/1 and the rest will go to the principal. And on 3/1, you will be charged interest only on the principal that is left over on 2/14 ... but for the whole month's duration. The only way you can make everything count against the principal is by making a payment and specifically notifying the loan servicer that it is for principal only. However, making a principal only payment does not change the fact that you still owe the next monthly mortgage payment on the 1st of the next month.

On the other hand, there is a simple interest loan, in which case also you are paying interest on the outstanding principal and that is also accrued until paid. However, there is a (key) difference - in simple interest loans, each day counts. If you make the payment on 1/30 instead of 2/1, you are charged interest for 29 days (assuming that the previous payment was on 1/1) and the remaining is paid against the loan principal. Also, if you make two payments on consecutive days, say 2/1 and 2/2, then the first payment will meet your obligation towards the payment due on 2/1 and the second payment will meet your obligation towards the payment due on 3/1. Besides, only one day's worth of interest will be deducted from the payment made on 2/2 and the rest will go towards the principal. Your next payment will then be due on 4/1 but there is a twist. If you pay it on 4/1, you will be paying interest from 2/2 through 4/1, i.e., nearly 60 days!

There are some mortgage products out there that are simple interest loans - for instance, my Home Equity Loan (HEL) with Penfed is one. But most of the mortgage products are fixed term compound interest loans.

- Porcupine
Thank you very much for the explanation! I think I am understanding, but there is one thing that still does not make sense to me. In my case, I paid the loan due on 3/1 and the payment due on 4/1 on 2/24 and 2/25 respectively. I understand that the entire month's interest is due (essentially) at the start of the month (and maybe even 14 days into the next). I don't understand how March's interest could have been triggered at all, unless it is essentially compounding for an entire month each time I make a payment--even if the month has not yet begun. I could understand if I waited until 3/1 to make the 4/1 payment, but I don't understand how it is compounding OVER a month in advance. So, on 2/25 I am being charged for the interest from 3/1-3/31? The only way this make sense to me is if, as TFB explained, the servicer just holds onto the payment for the entire month and then applies it on the actual due date. If this is the case, is there anyway that I can request them to apply it immediately (kind of like you request them to apply to principal, or to escrow, or otherwise)?
I guess my confusion/unease is that when you say "compounded monthly" that suggests that there is one day/month that the interest is compounded--so I do not understand how there could be $1800 in interest TWICE within the same month. When you say "compounded monthly" do you mean "compounded for each monthly payment"? So each payment is associated with 30-days worth of interest, regardless of when it is paid?
mnvalue
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Re: Help with Mortgage-speak!

Post by mnvalue »

The explanation that I've heard is that mortgages are different because they're often resold. (Whether or not yours has been resold at this time is irrelevant.) Your payments apply per the amortization schedule, unless you're explicitly making an "additional principal" payment. If you think about it that way (and why it's that way), it will hopefully make sense.
rr2
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Re: Help with Mortgage-speak!

Post by rr2 »

grabiner and tfb have explained very well.

You have two choices for an extra payment -- either the amount goes towards principal OR towards next months payment. You can't have both.

If you still need further convincing, make a spreadsheet of the principal balance versus interest paid.

Points to consider:
-- Remember that the monthly payment is a fixed amount. It does not decrease if more principal is paid.
-- All payments and transactions (unless payoff in FULL) are considered to occur on the payment due date.
rr2
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Re: Help with Mortgage-speak!

Post by rr2 »

moneypenny02 wrote:
Thank you very much for the explanation! I think I am understanding, but there is one thing that still does not make sense to me. In my case, I paid the loan due on 3/1 and the payment due on 4/1 on 2/24 and 2/25 respectively. I understand that the entire month's interest is due (essentially) at the start of the month (and maybe even 14 days into the next).
This is not correct. The entire months interest is due at the END of the month.
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Kosmo
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Re: Help with Mortgage-speak!

Post by Kosmo »

The explanations offered so far are very good. I think the part you're missing is this:
moneypenny02 wrote:Your payments apply per the amortization schedule
You got an amortization schedule in all the loan paperwork. If you can't find it, you can probably get one from your bank's website. And you can easily create one yourself in a spreadsheet. If you're on (say) payment 5, it clearly states how much of that payment is interest and how much is principal and when it's due. If you pay ahead of time, it's still payment 5 and the interest and principal are still as they are listed in the schedule. The only way you can change this are by explicitly saying your additional payment is towards principal. That will essentially "shift" the schedule to account for a change in principal, so you'll pay off the loan slightly faster. Your next payment will still be due when payment 6 is due, but the principal/interest will be slightly different than the schedule.

Making advanced payments will allow you to "skip" a month in paying according to the amortization schedule (you could make payments 5, 6, and 7 on consecutive days then make no payment for another 2 months). Paying additional principal will not change when any payments are due, but will accelerate the loan payoff so you'll be done with it faster and pay less interest over the loan life. Those are the only 2 options.
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archbish99
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Re: Help with Mortgage-speak!

Post by archbish99 »

Yeah -- I got confused the other direction, having to fight my wife's student loan servicers to get them to apply payments to principal rather than just saying we were six months early with her payments. But I have also had a mortgage servicer refuse to apply an extra payment because it "wasn't enough" to cover the next month's payment. It seems like it's always easier to make the regular payment bigger than required and never send more than one check per month.

Sounds like what you'd really like is a redraw or offset account, but I'm unfortunately not aware of a US mortgage that offers such a feature. They're pretty common in the UK and Australia, from what I understand -- basically a virtual checking account in which you can deposit extra money to have it taken off (offset) from the balance of the mortgage, but you can pull it back out again (redraw it) if you find that you need the cash in an emergency.
I'm not a financial advisor, I just play one on the Internet.
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jimb_fromATL
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Another perspective on what others are explaining

Post by jimb_fromATL »

moneypenny02 wrote:Thank you for the responses.

Re: whether I wanted to pay down principal faster or be able to skip a payment--Ideally I wanted to do both.
You cannot normally skip payments on mortgages even if you pay ahead. Even if they would do it, there would not be any point in giving the money to your mortgage lender for them to hold for free until you wanted to skip a payment, and it would not save you any time or interest on the loan. All they would do is put it in escrow and earn interest on it for themselves until you miss a payment.

So... I suggest that you just pay extra when you have it to spare to reduce the mortgage balance, and keep enough in your emergency fund to allow you to make a few mortgage payments if you're out of work or have some other kind of financial set-back.

Did that actually work with your student loan? I doubt it. I suspect that when you paid extra they calculated the interest since the last payment and then applied the rest to reduce the principal balance. Then if you missed a payment, they probably just added the accrued interest since the last payment to your unpaid balance.
It seems like what you are saying is that, basically, the servicer just holds my loan payment--made 33 days early and when there should be no outstanding interest on the loan b/c it was just paid--and applies it on the due date of the loan. Putting aside whether that seems legal, it also seems wrong (wrong with respect to what the servicer says they are doing), b/c the FAQs on my loan servicer's page specifically says that you cannot set up to do bi-weekly payments, but you can pay an additional payment in the year, and it will have the same result. If they are just holding that extra payment until it is actually due, then it doesn't seem to achieve any result whatsoever.
Yep, that is how it works. And it's legal because that's standard practice and what you agreed to in the contract.

Interest on normal amortized mortgages accrues at 1/12 of the yearly rate on the unpaid balance as of the normal one-per-month posting date regardless of when the payment is received, as long as it is received within the grace period before it's considered late. The only time interest is pro-rated on a daily basis is when you're prepaying the interest between closing on the loan and the next normal posting date, and from the last posting date to the day you pay it off -- as in refinancing or paying it off early as a lump sum.

Since interest accrues on the unpaid balance every month and the unpaid balance is being reduced every month, the ratio of interest to principal is different in every payment. The "minimum" payment is calculated to take that into consideration so that the same payment every month will pay off all the interest and all the principal in the exact number of months intially agreed upon in your contract.

When you pay more than the minimum payment, it reduces the unpaid balance more than the normal schedule. So the next payment will have less interest and more principal, which will cause the loan to be paid off faster with less interest. Since a loan is compound interest, a relatively small amount paid extra will save the interest that would have been paid on it for all the remaining time in the schedule. So it will save a lot more interest than the amount you pay extra.

But you can't skip payments, and you won't actually realize the savings until it's either paid off faster, or you refinance or sell before it's paid off, and realize the lower balance than you would have had with the original schedule.

You could think of the monthly payments and posting dates on a mortgage or other amortized loan like mileposts on a long trip with interest being paid at each post. Paying extra doesn't change the distance between mileposts, but it brings your destination closer to you -- so you don't have to pass as many mileposts or pay as much interest or take as long to get there.

Or as someone else described about skipping ahead in the amortization schedule, you could think of it as skipping ahead to a milepost further down the road, which also puts you closer to your destination. But you still have to pay interest on the unpaid balance when you reach the next milepost or posting date.


By the way, biweekly payments are just a gimmicky way to trick yourself into paying more than the minimum payment on yor mortgage over a year's time, and usually to pay your lender extra for something you can do with them by yourself for free.Here’s why biweekly payments work:
  • There are 12 monthly payments on a mortgage but there are 52 weeks in a year. If you pay half a month’s payment at exactly two week intervals, it will result in making a total of 26 half payments, or 13 full payments per year.

    Even when your mortgage company accepts biweekly payments ( or if they will even accept some other schedule or partial payments) the majority of them typically just hold the money for their own use and post it at the normal posting date at the end of the month. For biweekly payments on most mortgages you won’t see any savings until the twice per year interval when the 5th week in a month results in a extra half-payment being credited to your account balance.

    You can get virtually the same net result for free by paying 1/12 (8.33%) of the payment extra on the principal along with your regular monthly payment; or 1/2 an extra payment every six months, or 1 extra payment per year. Since you don’t pay extra for a setup fee or processing you’ll have even more money to apply to reduce the mortgage even more.

    Bear in mind that biweekly payments or the 1/12, 1/2 or 1 extra payment per year options are not some kind of magic formulas. Because of the way compounding works, with interest accruing on the unpaid balance every month, you'll save the most time and interest on the loan by paying as much extra as you can as early as you can in the schedule.


You should pay yourself first:

If you can afford to pay off a mortgage early, chances are that you have enough income and are in a high enough tax bracket for fed and state that your money will be put to better use to contribute the maximum you're allowed to any 401(k), TSP, 403(b) or IRA that may be available to you.

In fact because of compounding and never being able to make up for lost time and opportunity costs for investing, you can literally lose anywhere from tens to hundreds of thousands to millions of dollars out of your potential future retirement income in exchange for saving only a tiny fraction as much interest on a shorter term debt such as a mortgage.

You need to have a substantial amount of cash on hand for emergencies.
  • ...At least 6 months to a year of living expenses including the mortgage payment. If you have too much money tied up in home equity, you can't afford to take the chance of losing it all by not having enough money on hand to continue making the payments if you fall on temporary hard times such as a job loss or cut in pay.
Pay off higher rate consumer debts first to give you more room in your budget.
  • Not most student loans or car loans as long as you can comfortably afford the payments.
If you want to post details about your mortgage balance, rate, and time (or payment for P&I alone) I can give you a more specific example of how much time and money you would save on your mortgage with regular extra payments on the principal.

If you have a 401(k) or any other tax deferred retirement plan available that you're not contributing the maximum to already, and if you're a step or two above the bottom tax bracket, we can also explore how much you might lose from retirement for paying off the mortgage too fast instead of investing the extra money.

jimb
sscritic
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Re: Help with Mortgage-speak!

Post by sscritic »

You can do both at once if you are willing to pay thrice. I could fill out my "pay" stub as follows:
regular amount $1000
additional principal $1000
additional monthly payment $1000

Tomorrow, February 27, I pay them $3000. $1000 is the payment due March 1, $1000 is the payment due April 1, and $1000 is additional principal.
Twins Fan
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Re: Help with Mortgage-speak!

Post by Twins Fan »

Kosmo wrote:The explanations offered so far are very good. I think the part you're missing is this:
moneypenny02 wrote:Your payments apply per the amortization schedule
You got an amortization schedule in all the loan paperwork. If you can't find it, you can probably get one from your bank's website. And you can easily create one yourself in a spreadsheet. If you're on (say) payment 5, it clearly states how much of that payment is interest and how much is principal and when it's due. If you pay ahead of time, it's still payment 5 and the interest and principal are still as they are listed in the schedule. The only way you can change this are by explicitly saying your additional payment is towards principal. That will essentially "shift" the schedule to account for a change in principal, so you'll pay off the loan slightly faster. Your next payment will still be due when payment 6 is due, but the principal/interest will be slightly different than the schedule.

Making advanced payments will allow you to "skip" a month in paying according to the amortization schedule (you could make payments 5, 6, and 7 on consecutive days then make no payment for another 2 months). Paying additional principal will not change when any payments are due, but will accelerate the loan payoff so you'll be done with it faster and pay less interest over the loan life. Those are the only 2 options.
This... :sharebeer

I haven't had student loans before, but reading through this one makes me think of car loans vs. a mortgage. If one has a $15k car loan and throws an extra $5k at it one month, the car loan provider may (in my experience anyway) say your next payment isn't due until June of 2015 (for example). That person then really has the option of not making a payment until June of 2015, or they can continue making monthly payments to pay down the loan. If one has a $150k mortgage and throws an extra $50k at it one month or year, the mortgage company doesn't care. That person still owes a payment on the 1st of every month. But, the principal is reduced that much and less in interest is paid from there on.

No skipping by making extra scheduled payments on a mortgage. You are basically jumping ahead on the schedule, but not changing the schedule at all. Personally, I don't see any reason to make extra scheduled payments (or ahead) on a mortgage. You're still paying the same amount of interest, just early... which the bank would love. If you have extra to throw at the mortgage, throw it all at the principal so you pay less in interest and help yourself out.
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Cosmo
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Re: Help with Mortgage-speak!

Post by Cosmo »

With the advent of automated payments or the flexibility of scheduling your payments ahead of time and/or on a particular day, I cannot think of any practical example of why you would want to make an additional payment and NOT apply it to principal only.
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tfb
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Re: Help with Mortgage-speak!

Post by tfb »

I just remembered this piece I came across a few years ago:

A Finance Professor Writes About Prepaying Mortgage

Even a finance professor was confused about how it works.
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DonCamillo
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Re: Help with Mortgage-speak!

Post by DonCamillo »

I found it much easier to deal with a Credit Union than a bank. I had a 7 year balloon mortgage. Paid $1000 a month additional principal. At the end of 7 years, bank wanted me to refinance, pay appraisal and other fees and a higher interest rate. Went to my credit union, got a HELOC with no fees for the amount of the mortgage (at a lower interest rate) and paid off the mortgage. The credit union calculated my interest on a daily basis. I was able to pay off the remaining loan quickly, even paying extra amounts in between payments. I worked in the same building as the credit union, and could go in and just pay an extra $100 on my HELOC if I wanted. There was no problem with principal and interest. Every payment was applied first to interest from the date of the last payment to the current date, and the rest went to principal. I modeled it in a spreadsheet and my calculations only differed from the credit union on the occasional rounding of a penny. For some reason, the credit union always took an extra penny off my balance when there was a difference. I probably saved an extra 4 cents over the two years it took to pay off the mortgage :greedy .
Les vieillards aiment à donner de bons préceptes, pour se consoler de n'être plus en état de donner de mauvais exemples. | (François, duc de La Rochefoucauld, maxim 93)
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Re: Help with Mortgage-speak!

Post by ubermax »

This post is quickly slipping away from the first page and there have been a lot of good responses to the OP’s question; I think the OP has a good handle mathematically on the way a student loan works but I thought it might be instructive and worthwhile to illustrate the mechanics of a mortgage loan taking the same student loan payment timing applied to the home mortgage case.

Let’s say that a mortgage loan for L is taken on 1/1 with monthly payments of P (i.e. principle and interest), a term of 30 years, and at a nominal annual rate of K or a monthly effective rate of K/12, the first due on 2/1; the OP makes back to back payments of P on 1/25 & again on 1/26;

Situation #1: The payment on 1/26 is an additional payment towards the payment due on 2/1; the bank calls this an additional payment towards principle because the contractual interest due for the month has already been satisfied by the first P ; the outstanding loan balance on 2/1 is (L +(K/12)L – 2P).

Situation #2: The payment on 1/26 is an early 3/1 payment ; now the outstanding balance of the loan on 2/1 is ( L+(K/12)L – P ) or OB1 for short and the outstanding balance of the loan on 3/1 is (OB1+(K/12)OB1 – P) , i.e. no advantage to paying early as I think the OP noticed .

Again the responses were great – I just wanted to illustrate a little of the math that’s involved with the mortgage case – for the above described mortgage, whether that 2/1 payment of P is made early or within the grace period, the outstanding balance on 2/1 is the same – not so with the student loan.
cherijoh
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Re: Help with Mortgage-speak!

Post by cherijoh »

Nope, mortgages apply your payment as though it was made by the due date and typically do not credit you with the difference in interest as a principal payment. Conversely, you typically have a grace period, so if your payment is made a few days late you are not penalized. Since lots of people make their mortgage payment by ACH (an automated withdrawal set up to be monthly), the bank draws the payment on or after the 1st of the month but credits you as though it was made exactly on the 1st as far as amortization.

If you want to make an extra payment against principal it needs to be a separate payment with specific instructions to apply to principal. It is also a good idea to make it for a different amount than your standard mortgage payment so that it doesn't get mistakenly credited as being the regular payment.
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Re: Help with Mortgage-speak!

Post by sscritic »

DonCamillo wrote:I found it much easier to deal with a Credit Union than a bank. I had a 7 year balloon mortgage. Paid $1000 a month additional principal. At the end of 7 years, bank wanted me to refinance, pay appraisal and other fees and a higher interest rate. Went to my credit union, got a HELOC with no fees for the amount of the mortgage (at a lower interest rate) and paid off the mortgage. The credit union calculated my interest on a daily basis. I was able to pay off the remaining loan quickly, even paying extra amounts in between payments.
I don't think it was the credit union so much as the HELOC. HELOCs don't work the same as conventional mortgages. As the Mortgage Professor says:
Because the balance of a HELOC may change from day to day, depending on draws and repayments, interest on a HELOC is calculated daily rather than monthly.
This is what you observed with your HELOC. I saw the same with my HELOC from a now-long-gone savings and loan.
ubermax
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Re: Help with Mortgage-speak!

Post by ubermax »

cherijoh wrote:Nope, mortgages apply your payment as though it was made by the due date and typically do not credit you with the difference in interest as a principal payment. Conversely, you typically have a grace period, so if your payment is made a few days late you are not penalized. Since lots of people make their mortgage payment by ACH (an automated withdrawal set up to be monthly), the bank draws the payment on or after the 1st of the month but credits you as though it was made exactly on the 1st as far as amortization.

If you want to make an extra payment against principal it needs to be a separate payment with specific instructions to apply to principal. It is also a good idea to make it for a different amount than your standard mortgage payment so that it doesn't get mistakenly credited as being the regular payment.
Cherijoh, is your "nope" in response to my reply ? if so , then please explain where I have gone astray and to avoid ambiguity please frame your response using the parameters that I used :happy
Twins Fan
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Re: Help with Mortgage-speak!

Post by Twins Fan »

I think cherijoh was just replying to the OPs question of if the same system applies to a mortgage. Just happened to land under your post.... you're still on course. :D
ubermax
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Re: Help with Mortgage-speak!

Post by ubermax »

Twins Fan wrote:I think cherijoh was just replying to the OPs question of if the same system applies to a mortgage. Just happened to land under your post.... you're still on course. :D
OK , sounds good , thanks Twins Fan
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