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After having paid several years of 'extra' principal payment on my mortgage, I found that the extra monies were being applied the the 'back-end' of the mortgage instead of the 'front end'.

The reason this is important is that the mortgage interest on an amortized loan is higher on the front end than at the back end. If you look at an amortization table, the amount allocated monthly to PI (principal & interest) is not equal. The first several years of the mortgage is heavily weighted towards interest and very little towards principal.

A strategy some have said is to send exactly the amount of several months pre-paid principal payments along with the current months full P&I payment thereby not allowing the INTEREST for those future months of pre-paid PRINCIPAL to be collected. In other words. Payment #1 Principal & Interest PLUS payment of Principal for months 2, 3, 4 & 5 would circumvent Interest payments for months 2, 3, 4 & 5. That would save THOUSANDS immediately on the mortgage. Your next months payment would begin with Payment #6 P & I... and if you can afford to pay Principal for months 7, 8, 9 & 10... you would save even more THOUSANDS.

The problem with this strategy is that banks don't like it and do everything to discourage one from pre-paying up-front principal. They will gladly accept your payments and apply them to the 'back-end' of the loan.

I would like to know more about a method to force the banks to accept the payments on the 'front-end' to avoid paying interest. Is this possible? If so, how can I do this?

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Making extra principal payments equal to every other month will cut the loan duration in half, however it can be hard to keep up as the size of those payments get larger and larger. Another alternative is to look at the midway principal amount, and pay that much extra every month, it has pretty much the same effect in halving the loan, but is easier to budget for. –  Chuck van der Linden Jul 25 '11 at 21:19
    
Seems as if the calculator would give the best choice... but... I think it does not address the issue of preventling the LARGE interest payments early in the amortization table. If specific payments of early principal is paid early... then those corresponding large sums of interest would be avoided. I must admit that I can't tell for sure... but... intuitively if we are not avoiding the early interest payments by paying the front-end principal payments... then if the payments are being applied to the back-end of the mortgage... only the small interest payments are being avoided. –  user4253 Jul 26 '11 at 4:46
    
You still have to pay interest each month on the remaining principal, so you cannot ever completely eliminate 'right now' the interest you'd be paying for the next month via making an extra principal payment. You DO save the interest, but it's over the life of the loan. If you pay month 2's principal along with month 1's payment, then your next payment is effectively the one for month three, treat it as if you've removed the payment for month 2, and all the other months slide forward to fill the gap, and now you are paying a little less interest each month than you would have before. –  Chuck van der Linden Jul 26 '11 at 18:47
    
For your specific scenario above, treat it as removing the payments for months 2-5, everything slides up, you now are paying the interest/principal ratio for month 6, in your second month, and the entire loan will be paid off 4 months early. Perhaps a better way is to think of this issue is as if you were investing that extra principal payment, and getting a return worth 4 monthly payments, 29 years and 8 months from now when the investment pays off. –  Chuck van der Linden Jul 26 '11 at 19:04
    
Thank you all. Having read this post I will consider calling my bank to ask how they apply my prepayments. I was in a presentation where we were told that paying off the earliest payments or the latest payments made little difference but if the bank reduced each of the future payments a little bit, it was far worse for the borrower. –  user13337 Mar 2 at 11:06

4 Answers 4

You are presuming something that isn't true, which is that applying to 'back end' saves you less money than the 'front end' does. When you apply an extra payment to the principal as a whole, it ends up reducing the principal on which you are paying interest. This reduces the interest owed over the life of the loan, which in a sense shifts the interest/principle allocation for every payment after the reduction in principle. A loan for a lower amount with the same duration would have lower payments, but since the payments don't drop, each one is now effectively paying off a tiny bit more principal than before, which means the loan is paid off quicker. If you reduce the principal by an amount equal to the next months principle payment, it effectively strips a month off the life of the loan.

No matter which way you do the math, viewing the coming month as removed and shift up the others, or viewing all following payments as now having a reduction in the portion that is interest, the end result is the same, the loan is paid off sooner

You can use the calculator at this site (or google for another) which allows the option of a one time payment. and view the effect and prove I'm right about the math on this.

For example, start with their default numbers, and have it calculate the payoff date. Make a note of what that date is. Then click the green 'show year by year' link, and expand the first year (click the plus sign) to see the month by month details for that year. Now, take the principle amount for payment 2, stick it in the 'one time prepayment' field, and put a 2 in the 'before payment number' field. Have it re-calculate and you will notice that it stripped a month off the payoff date of the loan.

Of course we don't know the guts of that calculator so maybe it is applying the extra payment the front of the loan? maybe not. No matter, we can do the numbers a different way to simulate the 'back end' method and see what result we get.

To prove the reduced interest math, do this. Put in 155,000 for the loan amount. Notice that the second month's principal is 187.02 Round that to 187, subtract from 155,000 and enter that number (154813) as the loan balance and re-calculate (to get payments for a loan reduced by the first extra principal payment. Notice the monthly payment is 1$ lower. Now put $1 into the monthly prepayment field, (so we are making the same payment as for the original 155k loan) and recalculate. The end date moves up one month. So yes, that tiny shift in effectively paying $1 more towards principal on every payment along with the prepayment itself, pulls a month off the end of the loan.

Hence no matter if it goes to the 'end' or the 'front' you will save one entire payment, less the amount of prepaid principle, which is equal to the interest payment for month 2. Same net effect in total savings no matter how you do the calculation

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Great explaination. When I first got a mortgage I had a similar idea as the OP (but I was more focused on how much "interest" I would be able to deduct from my taxes). I think the confusion somes from those payment tables that show how the principle and interest changes over time (with the same monthly payment). Looking at these tables made me think if I was "pre-paying" I would end the loan early but the IRS would still think I was paying the same interest as someone who did not prepay. This is wrong, the bank will use the actual insterest on the principle, not the number from these table –  auujay Jul 26 '11 at 17:21
    
Yeah some folks have a hard time wrapping their head around this one. If you are meaning to do this, the easy way to see the reduction in the first year's interest payments is to add up the interest for the odd months, 1-23 and compare that with the interest for months 1-12. Your extra principal payments will be for the even months 2-24. The payoff date on the loan is now one year earlier and the total savings to you is one year worth of payments, less the extra principal you payed (technically less whatever you could have earned on that money investing it elsewhere). –  Chuck van der Linden Jul 26 '11 at 18:54

First, you need to check the terms of your loan agreement to make sure there is no pre-payment penalty or contractual basis for them to apply extra payments in any other way than reducing the principal immediately.

Once you have confirmed that, you need to make sure to include with any extra payments instructions for how the overage is to be applied. Ideally you would write this in the memo section of the check in addition to a note with the payment.

I'm not sure about your back-end/front end theory, but I have seen where the lender can sometimes interpret extra payments as pre-payments of future monthly payments instead of applying them immediately.

Summary: If you are clear about your intentions and they don't have something written into the loan agreement to the contrary, this should be fairly trivial. In fact, I did it all the time with no issues at all on my mortgage with Wells Fargo.

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+1 for checking about pre-payment penalties. –  Rick Goldstein May 28 '13 at 2:41

Some time ago, I wrote a spreadsheet to help understand the impact of mortgage acceleration. (Note - I don't sell it, or anything else for that matter. I wrote it in response to mortgage acceleration scams, as a way of showing how simple the actual process really is.) The sheet allows you to change the principal amount, interest rate, and prepayments. You'll note that for the numbers loaded, ($200K, 6%, 30yrs) a prepayment of $200 at the outset knocks off a full payment at the end. Of course today's principal drops by just that $200, but its effect is multiplied over the 30 years. You can see how the amount of interest and principal changes each month, and how if in any given month you pay exactly "next month's principal" you cut a month off the back end.

Since interest is calculated based on the principal amount in any given month, it's not linear. I believe the term 'front-loaded' confuses the issue and adds nothing meaningful to these dialogs. You owe $200K. The interest rate is 5%. Why would anyone be surprised the interest in that first 12 months is close to $10K? And toward the end, when your balance is say, $50K, that year's interest is closer to just $2500?

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+1 for the last paragraph. This should be obvious, but clearly isn't to everyone. –  Rick Goldstein May 28 '13 at 2:40

Unfortunately, one of the characteristics of an amortized loan is that you pay interest up front and principal on the back end of the loan. If you are very aggressive about paying the loan down and pay off a significant percentage in a short period, you can ask the bank to re-amortize the loan to reduce the payments.

To do what you want to do, you need to find a "simple interest" mortgage. These exist, but are rare since the government doesn't buy them. A simple interest mortgage accrues interest daily similar to a credit card, so the lower your balance, the lower the interest payment.

These loans may or may not be a good deal for you, depending on a number of factors. Run the numbers carefully and understand what you are getting into. There's no such thing as a free lunch.

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Yes Duffbeer... agreed! But it does not have to be a simple interest loan. In an amortized loan, what we want to do is defeat that system by paying the principal payments associated with the earliest interest payments to AVOID those corresponding interest charges. Can this be done??? Is there a clause in the mortgages that prevents this method of paying down the principal and avoiding the corresponding 'early or front-end' interest payments??? Is there actual legal precedence for cases involving a mortgagor invoking such a pattern of payment? –  J A Farr Jul 26 '11 at 16:09
    
Nothing "unfortunate" about paying more interest early in the loan and more principal later. It's strictly a matter of the mathematics of paying off a fixed interest loan in a fixed time period with fixed payment amounts. If you want to reduce the total interest paid over the life of the loan, use a shorter amortization schedule (15 or 20 year), or prepay specifically to principal. There's nothing to "defeat" here. See the last paragraph of @JoeTaxpayer's answer. –  Rick Goldstein May 28 '13 at 2:38

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