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I read this post which answers a reader's question about how her additional mortgage payments were applied to her loan. A short version of the question: She had been making additional payments on her mortgage, and her next payment is due officially in six months. This means she's been prepaying her mortgage payments instead of applying the additional payments to the loan principal immediately. A short version of the answer: This isn't the best idea, as it doesn't reduce the amount of interest paid, and the bank holds the money, interest-free, until applying it to the loan balance. It would be best to request that the bank apply the extra payments "properly," or at least make sure that future additional payments are applied to reduce principal. Use of the word "properly" -- which is what the blogger used in his answer -- bugs me a little bit because it makes it appear that making advance payments has little or no merit. What advantage could there be to "buying time" by getting ahead a few payments? I can't imagine that this argument is quite that one-sided, but I could be wrong! ;) |
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The only reason I could think of would be if you left the country on a slow boat, and you wanted to make sure your house was still yours when you returned. The better way to do this would be to have the payments automatically transferred while you are gone. Otherwise, it just gives the bank use of your money for nothing. Now considering how low money market rates are at this time, all of us with passbook, and money market accounts are essentially doing the same thing. But from a building wealth and personal finance standpoint, paying down principal makes a lot of sense: being out of debt earlier, and less interest costs are obvious ones. I can't think of any benefits of pre-paying. Don't think the mortgage company was doing anything "improper" just what is in their best self interest..... |
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Interesting question! I actually had my credit union try to refuse to apply a prepayment toward principal. Their rep claimed it was against the CU's rules and that they were required to apply prepayments toward interest (!!). Because I had paid off a previous 5-year loan in 18 months by applying every extra penny toward principal, I knew this story was a fairy tale. I raised He** and put a block under it, right there in the lobby. To shut me up, they trotted out the manager, who backed & filled and finally admitted that, of course, no rule against prepaying principal existed. As it developed, to discourage customers from doing this, they kept tellers in the dark about it: you had to write a secret code on the check to get it applied to principal. The code is "LOPC." I don't know what it means & don't know if it's exclusive to my C.U. The C.U. will accept a check marked "LOPC," but it truly is impossible to apply cash toward principal in an electronic transaction. There's no benefit to prepaying interest, except to the bank, other than that later you can skip a payment if you expect to be short of cash in the future. That is crazy! Good to know, too.
(Nov 28 '09 at 05:33)
Dogfood Provider
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It's a bit late, but I'll throw in my $0.13 (yes, I'm better than everyone else, so I get more ;D ). My wife and I moving into a fairly tight period financially. I'm going back to school and she's staying home with our children. With student loans and my Ph.D. stipend, we'll be making about 35% less than when I was employed. OK, enough with the background. Here's why paying ahead might be useful: I get payouts twice a year, so our money has to stretch for 6 months. By paying our mortgage payments 6 months out, we don't have to worry about losing the house. Granted, we don't have the money for an emergency, but we could draw against retirement for that if we had to. Does it make the best sense financially? Not really, unless you consider the financial ruin which could come from a house foreclosure. If I was getting paid monthly, I wouldn't even think of it (in fact, we've paid more than the minimum in the past and have managed to build 25% equity in only 5 years), but if you just get a few large disbursements a year, it might be a good way of effectively placing that money "of limits." (Yeah, sure, we could put it in another account, etc, etc, etc, but I'm just arguing for a case where it might be a worthwhile move to pay ahead). Welcome! That's very interesting how you get your payouts. I was a Ph.D. candidate for a while myself, and I always got biweekly checks. Substantially different than what you have. Good luck with your degree!
(Aug 28 at 22:13)
mbhunter ♦♦
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