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I've heard for years - and not believed - that it was necessary to mark extra payments, clearly targeted towards a particular loan, as "apply to principal" or any other such magic wording in order to get the payment properly applied. Are there circumstances in which this is true? If so, what happens to a misapplied payment?

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It could be a couple of things besides extra principal:

  • Future payment. If your payment is $500/month, and you write a check for $2,000 applied to future payments in January, you wouldn't need to make another payment again until May. This is different than applying to principal, because if you did that, you'd still owe $500 in February, but would be closer to paying off the loan.
  • Escrow payment. If for some reason you wanted to fund your escrow account (for tax and insurance payments made on your behalf by the lender) more than its current level, you could do this.

I seem to remember hearing that some (shady?) lenders would just pocket extra payments if you didn't specify where they were headed, but I've also been told that this just isn't true.

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  • 'greedy' as in 'greed is good' might be a better phrase than shady.
    – Chuck van der Linden
    Commented Jun 17, 2011 at 6:40
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The mortgage I got last year through Wells Fargo explicitly indicates in its terms that excess payment will be considered against future payments (i.e., pay $500 extra in January and you owe $500 less in February) unless you indicate otherwise. It goes on to state that with electronic payments you do not get to specify where excess payment goes, so excess payment made electronically always goes toward future payments. If you want to make excess payments toward principal, you must actually send them a check and your payment stub, with the appropriate box ticked.

This won't be very different for other major banks, I wouldn't imagine.

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    This is actually very different from my bank. Countrywide and now Bank of America have three extra boxes in their online payment form: "Additional Principal", "Escrow" and "Other" (other is used for "special fees or late charges"). I think the only way to make a "future payment" (I've done it once accidentally) is to just submit the whole form again.
    – Nicole
    Commented Jun 16, 2011 at 22:42
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    That's pretty evil, because it means you don't get any interest on the excess payment.
    – Ganesh Sittampalam ♦
    Commented Jul 9, 2011 at 21:06
  • I have a very different experience with the US Bank which would randomly assign payments to either future or principle depending on... the weather in Kansas, I want to say? Not sure.
    – littleadv
    Commented May 18, 2022 at 23:55
  • I've had two mortgages, back in the last century. The check was mailed with the payment coupon, anything extra in the check simply paid down the principal.
    – Loren Pechtel
    Commented May 19, 2022 at 1:12
  • @littleadv When I had a mortgage with US Bank it appeared that any payment that matched your monthly payment amount would be applied to your next outstanding payment, while any other amount would be applied to principal. It became an issue one year when my escrow amount decreased and was off by a month in adjusting to it. My payment was slightly larger than the monthly payment amount, and that caused it to get applied to principal, causing it to look like I had missed my payment for the month. It took a two-hour phone call to clear it up.
    – Nobody
    Commented May 19, 2022 at 13:13
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I had a car loan through GMAC and extra money was applied to future payments. At one point, I received a statement telling me I had 15 months until my next payment was due because I had not marked extra payments as going to principal.

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I would always presume that given a choice of doing what is in its own self interest verses in the customer's interest, a bank will ALWAYS do the former rather than the latter.

Banks are in the business of making money, always presume that their policies, processes and contractual terms will be slanted to maximize their ability to make money. It's not being evil or anything, it's just business, they are under no obligation to be altruistic or do what's best for you at the expense of their profits.

So, especially since it's not exactly a hardship, I would always make extra principal payments using a separate check and clearly mark it as an extra principal payment.

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