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I have a 30 year mortgage and I'd like to make extra payments each month to speed up the amortization schedule. I thought this would be better than taking out a 15 year mortgage as it gives me some added flexibility in case I need it at some point. There are a lot of similar questions but I didn't find any that answered this specifically.

When making these extra payments, do I need to tell the bank that these payments should go towards the principal or will it happen automatically? I realize it sounds absurd that a bank would take an extra payment and apply it to interest which would be like stealing my money... but then again, these are banks we are talking about.

When I use a loan amortization calculator, that is the way that it treats my extra payments (applies them to principal) and so if I use this to model my amortization schedule, I want to be sure this is how it will work.

Thanks for your help in advance.

  • Have you asked the [thieving] bank? – quid Aug 17 at 0:08
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In your title you ask what happens typically. In the body of the question you ask if you have to specify how the extra payment will be treated.

The answer is you have to ask your lender about your loan. My loan is through my credit union. I can make an extra payment anytime I want. The form on the website allows me to specify if the payment is to be treated as a regular payment (part interest and part principal), or only principal. They don't require the extra amount to be part of the regular payment on the 1st of the month. They even give me the option of making it a recurring payment (weekly, on the xth of the month, every payday...)

But that is my situation. Some may even be more flexible, some may be much less flexible. You have to ask about your situation. Check their website for a method to make the payment electronically, and see what the options are. Because you already have the mortgage you have to work with your lenders rules.

I should also add you need to make sure your loan doesn't have a pre-payment penalty.

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Mortgage rules differ by country, and within a country they further differ by the lender.

Assuming this is in the US, and based on my limited experience (2 mortgages), you can only add extra payment on top of a regular payment. For example, if your regular payment is $1000, and you want to pay $500 extra, you make $1500 payment.

Regular portion of the payment covers all of the interest accrued since the last payment, and some principal on top of that. And then all of the extra goes towards principal.

Going into more details, payment form - both online, and on the paper coupon that you attach to the check - has the regular payment amount filled in, and then few more fields below, to add extra principal, extra escrow, and fees and penalties, in case they apply. That way you explicitly specify the intent of the extra payment.

Note that extra payment towards interest is impossible and makes no sense - you only owe interest accrued since the last payment, no more and no less. You cannot pay more interest than you owe, and you cannot pay less interest either. Interest payment is part of your regular payment.

These rules may differ by lender, so someone with more exposure to mortgages from different lenders may provide broader coverage on the subject.

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    It is possible to prepay interest and I think this is what people are concerned will happen if it isn't applied to principal. That is, an overpayment of $X would simply reduce the next payment due (or even worse, the final payment due) by $X -- giving the bank an interest-free loan. – nanoman Aug 17 at 1:09
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    Lender may allow making payments for future pay periods, which effectively prepays interest before that interest has been accrued. Not sure if this is what OP meant. – void_ptr Aug 17 at 1:18
  • I think it's what OP meant by "bank would take an extra payment and apply it to interest". So I was responding to your remark "extra payment towards interest is impossible and makes no sense". – nanoman Aug 17 at 1:30
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    It does make no sense that a lender would use excess payment to prepay interest, but it is possible and has happened. Effectively you prepaid but got no credit for having prepaid--interest computation went forward as if you had made those future payments on time but not early. – farnsy Aug 18 at 4:16
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    It allows me to make regular payments for future months in defense of the bank, this is the "default" as a way to protect (ignorant) customers. If extra money was automatically applied to principal instead of the next due receivable, people who thought they were sending the next month's payment early would get a nasty surprise when they were notified that they missed a payment. – dwizum Aug 19 at 13:22
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You'll have to read your mortgage contract and/or ask the mortgage company.

Let's say you have a 30 year mortgage with fixed interest rate, and you are supposed to pay $1,000 every month. This month you pay $2,000.

One way the mortgage company can handle this (which is not very nice for you financially) is to stash the $1,000 away, and if you don't pay your $1,000 in some later month take the difference from the $1,000 they stashed away. So you can pay $500 for two months. Or they wait until the 30 years are almost over, and don't ask for the $1,000 payment of your last month, because that's already paid.

The other way, they take the extra $1,000 and subtract it from the principal. You still have $1,000 to pay every month. So now your principal is $1,000 lower. So in the next month, your interest is a bit lower, so of your $1,000 payment, more money is subtracted from the principal and so on. You finish paying your mortgage earlier than after 30 years. At least a month earlier, but probably more (and/or the last payment will not be the full $1,000).

My bank used a variation of this: They assumed that my mortgage was over 30 years, and once a year they calculated how much I would have to pay every month to finish after exactly 30 years. So once a year they changed my payments to a lower amount because I overpaid through the year. They had a direct debit taking the required amount out, I had a standing order paying extra money every month, so every time they lowered the direct debit I increased my standing order, until everything was paid off.

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    You'll have to read your mortgage contract and/or ask the mortgage company. Unless it is in the contract or there are laws in place, the bank is not obligated to allow you alter the contract. In the past, some mortgages had prepayment penalties, newer laws have restricted this practice. – Mattman944 Aug 17 at 17:09
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It depends on your mortgage company, and how they've set up their web site**. If you happen to be with Bank of America, when you make a payment, you'll be given an option to include an extra amount. If you check this, you then get a choice whether the additional amount will be applied to principle, escrow*, or "other", which I suppose could include such things as late fees (though I've never used it).

*Many, perhaps most, mortgages maintain an escrow account. A fixed amount is paid into it with every payment, and the mortgage company pays taxes & insurance from the account when due.

**I suppose you'd have similar options if paying by check &c.

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