Prepayment penalty and interest arrears

4 Replies

Hey All,

I have a question about prepayment on conventional loans. The mortgage loans I'm currently after all state "no prepayment penalty." Say I am a few years into my mortgage and I believe I can pay a little extra on top of my normal monthly payment. If I make my normal payment of say $1500 on the normal due date of the 1st of the month and I decide to pay an extra $1000, this means that $1000 should all go to principal correct? Of course this is assuming no sneaky unpaid interest clause is in the loan despite a "no prepayment penalty" statement.

My second question is this:

If I make my normal payment of $1500 on the 1st and I decide to pay $1000 on the 15th of the same month, the lender would bill for interest in arrears (interest accrued from the 1st-15th) before directing the rest of the $1000 to principal right?

I just want to make sure I am understanding this concept of arrears correctly and to make sure that this is normal when "no prepayment penalty" is stated. 

Thanks in advance,

Daniel

Daniel,

Conventional mortgage loans generally don't contain a prepayment penalty, as you have mentioned.

Generally, your best course of action is to send two separate checks, one for the payment, the second marked "Principal Payment", along with a letter stating it as such. I would not leave it up to the servicing folks to make decisions for you. Most are wonderful people, however, they are processing thousands of payments per day. They aren't in your head (thankfully) and it's better to make it clear than to "assume" what is going to happen. 

I can tell you, no matter what your individual docs say, and what you want to happen, it probably won't come out the way you think. It will get straightened out eventually, but you will be pulling out your hair in the meantime. Also, once a loan is screwed up in the servicing system, it has a tendency to stay that way. 

The concept of arrears generally comes into play when payments are not made on time. In this case, the older due penalties and payments are paid first, then any leftover applied to the more recent penalties and payments. It's not generally applied to current mortgages with additional payments coming in mid-cycle.

Hope that helps.

Good Luck!

Jim

Thanks Jim. So this means that in regards to my second question assuming the mortgage does not have any missed payments, my extra payment on the 15th of the month should fully go towards principle. If I am being told by a loan rep that my extra payment on the 15th would first be applied to interest in arrears (interest accrued from the 1st to the 15th) then there is another cost outside of a prepayment penalty that is in play correct?

My goal is to get a loan with the lowest to no cost of prepayment. I've heard stories of people being told their loan has no prepayment penalty only to find out that their loan is actually subject to a prepayment cost. Things like the rule of 78s causing them to pay towards unpaid interest before principle or balance is paid down. This would even affect refinances potentially. 

Daniel,

Nope.. it's just how the docs written. The docs control the application of payments. On a current loan, you should be able to send in a principal payment at any time. If it's not specified as a principal payment, the they will probably follow what they are saying (apply to accrued interest, then principal). 

Double check your docs about the application of payments and how to pay a principal payment. Once you read that, you should be able to tee them up and get it to go.

You could, when you talk to them again, ask them how you would send in a principal payment in the middle of the month. If they give you the same line, then ask them how you would go about doing it with the monthly payment. 

You aren't going to get a conforming loan (or probably any loan) with a different set of application of payments rules. They are pretty much all boilerplate. As long as you know what you are getting into going in, then you can maneuver as best you can. The lender is the house, and they always win.

Good Luck,

Jim 

The rule of 78, if it still exist, isn’t in standard mtg,s. As for the payment on the 15th, no it would all go to principal....your following pmt on the 1st of the next month includes the interest for prior 30 days.

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