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We are trying to pay off our 20 years fixed mortgage after 12 years and when I called the mortgage company and asked for the balance (in my calculation is only 57000 of the principal left) the customer service tells me that I have to pay the whole balance with the interest. I can not comprehend why I have to pay the interest if I'm paying off the whole loan?

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    Check your mortgage agreement. Does it allow prepayment/early repayment? – Mark Plotnick Jul 8 '15 at 23:35
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    What country is this in. – Dheer Jul 9 '15 at 3:57
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    Mortgages are usually pretty low interest - perhaps it would be better to put that in a higher yield account instead? – corsiKa Jul 9 '15 at 14:48
  • @corsiKa: interest rates have gone down a lot in the last five years or so, if he has an older fixed mortgage rate it's probably higher than what he can get on a savings account. – RemcoGerlich Jul 9 '15 at 21:58
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    I'd expect $50k to go in something better than a savings account, but that's just me i guess. – corsiKa Jul 10 '15 at 0:48
23

You owe them for the interest that has accrued since the last payment was credited to your account.

When you sell a house with a mortgage the settlement company actually gets the payoff amount for a few days after settlement, to account for the mailing of the check after settlement has occurred. If they get it there a day earlier the extra amount is refunded to you.

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    Just to be clear, this is only the interest for the last few days (maybe a month at most). So if you have $57,000 at 5%, that's something on the order of .05/365 = .00014*(57,000)=$7.80 per day (approximately, and I'm leaving out some details such as compounding). So if you're paying it off on the 10th, and they'll get the check instantly (e-check, or else calculate this for the day they likely receive the check), and your mortgage is due on the 1st of each month, you probably owe ~$80 extra in interest (if @ 5% annually). – Joe Jul 8 '15 at 22:22
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    I have absolutely zero idea on what this answer is trying to say. I'd suggest a complete reword. – o0'. Jul 9 '15 at 10:35
  • This seems to be a very US-centric answer. – Eric Jul 9 '15 at 18:23
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    @eric Do banks in other countries not charge interest since the last payment? In what way is this answer US-centric? – Jay Jul 9 '15 at 22:16
  • This answer reads fine to me. I've owned houses on three continents (in Ireland, Australian, and the United States). This answer, or a variation of it as far as the terms used, is pretty much spot on. – Peter K. Jul 10 '15 at 21:47
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When a bank or mortgage company issues a mortgage, they are creating a future stream of profit for themselves (i.e. the future interest payment less their expenses). This profit stream is accounted for in their books, and sometimes the future profit stream is even sold off to other companies or investors in the form of mortgage backed securities.

If people cancel their mortgage, and pay back the outstanding capital amount, they are losing out on the future stream of profit already allowed for. In essence, you are taking something away from them that they hoped to keep.

It all depends on your loan agreement, but based on your description, your agreement probably says that early cancellation still requires to to pay for the future interest so that the bank / mortgage company does not lose out. This is regulated in some countries to protect the consumer, but not in all countries.

In summary: cancelling a bond early reduces the profits of a mortgage company, and they want to charge you for this.

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    Which is why it's important to ask about such terms before signing on the dotted line, whether for a house, a car, a boat, or any other significant capital purchase. – bishop Jul 9 '15 at 14:42
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    In the Netherlands, you typically pay a penalty related to (but not the full amount of) the amount of lost interest to the mortgage provider if you repay more than 10% of the mortgage in any given year (special circumstances aside). – Eric Jul 9 '15 at 18:25
  • This really isn't applicable to the question at least in the US. The answer that mhoran_psprep gave is accurate. – stoj Jul 9 '15 at 18:58
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    @stoj the OP didn't specify the country. This answer does say that it's "regulated in some countries". Seems as applicable as an answer can be. – Tim S. Jul 10 '15 at 2:24
  • Since repaid principle is almost certainly quickly put into another interest bearing loan by the lender, there is little if any lost future stream of profit. And if any new loan might have better interest terms, it's just as likely that a lender will have increased profit from full prepayment. – user2338816 Jul 10 '15 at 6:06
8

I will bet you the value of your mortgage that the loan contract you read and signed (you did read it, right?), will spell out in meticulous detail exactly if and how the contract can be paid out early and what fees, charges and interest will apply if you do so.

In addition to interest that has accrued since your last payment, for fixed rate loans there is generally a break charge to compensate the bank if interest rates are now lower than when you fixed the rates (e.g. you borrowed at 5% and market rates are now 2%).

1

There are two possible answers to your question:

  1. As mhoran_psprep says, they are charging you the interest that has accrued since your last payment. If you look at the outstanding balance, this is usually the balance as of the last payment, not including interest since then. So your payoff balance is slightly larger.

  2. Some loans have a "prepayment penalty". That is, if you pay the loan off early, you still have to pay some portion -- sometimes all -- of the interest that you would have paid if you had paid it off on the original schedule. Check the paperwork on the loan. In the U.S., most mortgages have no prepayment penalty. But many smaller loans do, with the exact formula used varying.

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    All you need to do is add "it all depends on the agreement you signed when you took out the loan - check your paperwork!", and you'll have the perfect answer covering all parts. And your paraphrasing of Dale M's answer will be complete :). (NB This last bit is a slightly tongue-in-cheek comment; I have given you +1 as I think your answer is much better worded than Dale M's.) – AndyT Jul 10 '15 at 9:49

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