For those who try to prepay their mortgages, here’s a cautionary tale from reader RM. Basically every single time that he’s prepaid his mortgage, there’s been a big problem. The bank keeps applying it to the future interest instead of the existing principal. The future interest is calculated based on the current principal, so that means they’re having him paying extra interest that would have never accrued if they had subtracted his payment correctly!
By the way, publishing sibling Consumer Reports ran a few statistical models and found that you’re probably better off financially putting extra money in a mutual fund than prepaying a mortgage.
But, if prepaying gives you peace of mind and investing in your emotional satisfaction is more important than the financial benefit, go for it. It’s kind of like a conservative investment. Just keep RM’s story in mind. He writes:
I have had a mortgage with Chase for nearly 4 and a half years. In that time, I have been able to cut the principle owed by more than half by paying a little extra each month with sporadic larger lump sums as I am able. The extra amount was always applied to the principle until I made an extra $20,000 principle payment last year, paid at the same time as my usual principle and interest payment. Inexplicably, Chase decided to apply nearly $2000 of the extra payment to principle and interest for following month (due date 34 days away). The interest calculated into that extra payment was calculated without the extra $20,000 removed from the principle.
Fortunately, they reversed the funds when I called them on it and the $20,000 was appropriately applied entirely to the principle. The amount of interest initially paid as part of the extra monthly payment was $1368.16. When I actually paid one month later (and interest had accrued on my principle, now $20,000 lower), the amount paid to interest was only $1,240.66. Had I not forced them to apply the extra payment completely to principle, Chase would have “earned” an extra $127.50 of pure profit.
Fast forward to more than a year later, when I was fortunate enough to be able to pay another $50,000 toward the principle. We made the payment of $50,000 plus the usual monthly payment 13 days early, figuring that 13 days of interest on $50,000 was worth saving. Today, I received the statement showing credit for an extra monthly payment (not due for 45 days), again effectively having me prepay a month’s worth of interest that would never otherwise accrue on that $50,000. The interest charged for the extra month was $1095.20. When I pay next month on a principle balance $50,000 smaller, the interest would be $779.90. Again, Chase tried to charge me an extra $315.30 interest on money that I no longer owed them.
Each time, Chase has been good about reversing the charges and applying the payments correctly. But I am certain that they are counting on most people to not realize that they are getting scammed out of a month’s worth of interest on the extra payment if some of it is applied to their next payment more than a month in advance.
This is pretty common occurrence with all kinds of loans, including student loans, so you better check your statements carefully after prepaying, and call the bank immediately if it looks like they applied your extra payment to future interest instead of paying down the principal.