How much did this cost me?

[pgwenthold]

OK, I hope I get all the details you need. I just got a call from our mortgage company. Apparently, for the last 4 months or so, they have not been properly applying our extra principle payment. Instead, they have been only treating it as a partial payment of our monthly payment, which is paid automatically (meaning we pay less at the end of each month). As a result, we have not made about $900 of extra principle payment on our mortgage over the last 4 month as we had planned.

Now, aside from the fact that we should have noticed the difference on our monthly balance, and so it was our oversight in that respect, I am wondering, how much will that cost us in the end? I don't need it to the penny, but an estimate. Here are some financial details

Currently, the mortgage is set to mature on 11/1/2035 (original loan was $256K on 10/11/2005), with a balance of 236 082 and an interest rate of 5.875% (we did look into refinancing recently, but doing so would have shot our home equity credit line (housing crunch!), which we need right now for another project)

If we had been making those payments properly, assume that it would be about $900 less, or $235 200. Same maturity date, same interest rate

How much more interest will we have paid assuming that we pay the standard payment? What if we pay an extra $200 a month on principle (as we intended)?

Any help would be appreciated.

BTW, even though we failed in that we didn't catch the error, it most definitely is a bank error, as that payment is indicated as a "principle payment" on the loan. The bank knows it, and they are blaming a "new" person handling the account.

 

[pgwenthold]

BTW, I realize I could just drop the $900 on it now and make up most of what we lost (leaving only the interest difference over those couple of months), but I'm curious about the result.

 

[NoZed Avenger]

State laws may vary (and I am unsure if this is covered federally or even if you are in the U.S.), but I know here that extra money *must* be applied to principal.

So I'd have the bank figure out the math, apply the money correctly to reduce your principal and erase the extra interest charges, and then confirm it all in writing.

 

[pgwenthold]

State laws may vary (and I am unsure if this is covered federally or even if you are in the U.S.), but I know here that extra money *must* be applied to principal.

The way they did it, though, it wasn't "extra" money. It was "partial, early payment" applied to the amount due for the next statement. Therefore, instead of paying $1700 in the monthly payment, they would only take $1600 (or whatever the difference was). They were TOLD to take the full payment each month, and to take an extra $100 ever other week to apply to principle. That's not what they were doing.

 

[NoZed Avenger]

The way they did it, though, it wasn't "extra" money. It was "partial, early payment" applied to the amount due for the next statement. Therefore, instead of paying $1700 in the monthly payment, they would only take $1600 (or whatever the difference was). They were TOLD to take the full payment each month, and to take an extra $100 ever other week to apply to principle. That's not what they were doing.

If I am understanding you correctly, a check marked as principal payment must be applied that way, so I think it is still the bank's responsibility to apply it properly, straight to the principal. Are they refusing to fix it?

(Or are you trying to decide whether it is worth bothering with before asking? If so, I'll let the more mathy people talk)

 

[Ziggurat]

How much more interest will we have paid assuming that we pay the standard payment? What if we pay an extra $200 a month on principle (as we intended)?

Any help would be appreciated.

Go here:
http://www.vertex42.com/Calculators/home-mortgage-calculator.html

Download their Excel mortgage calculator. Plug in all the loan details at the top. Enter your $900 however you want in the Additional Payments column (the yellow one). You'll see the total interest savings under the Extra Payments box near the top. You can also use this to calculate the tax savings you get.

 

[pgwenthold]

If I am understanding you correctly, a check marked as principal payment must be applied that way, so I think it is still the bank's responsibility to apply it properly, straight to the principal. Are they refusing to fix it?

I'm not sure what the effect really is, though. The calculation I mention above is only the tip of the iceberg. To get the real cost would be a lot more complicated.

The question is, what difference does it make if a partial, early payment is applied to principal or to interest?

So suppose the due date for a payment is the 28th of the month, and I owe $1400. On the 14th, I pay $200, and on the 28th, I pay the other $1200. How much does it cost me if that $200 was applied to interest vs principal? That is something I don't even know where to start.

 

[Ziggurat]

I'm not sure what the effect really is, though. The calculation I mention above is only the tip of the iceberg. To get the real cost would be a lot more complicated.

The question is, what difference does it make if a partial, early payment is applied to principal or to interest?

None. Interest is accrued monthly, it doesn't matter when you pay it, and even your regular payments are always applied partly to the principle (unless you've got an interest-only loan). Because you didn't pay more during that period than your normal payment, you get no savings.

The point of putting "principle" on your check, as I understand it, is two-fold: to notify the lender that it's an extra payment (ie, they should have still charged you the full $1400), and to notify them not to apply the payment to a future monthly due (ie, pay $1600 this month and $1200 next month). But paying $200 at the beginning of the month and $1200 at the end isn't any different than paying all $1400 at the end.

You've still got the money that you originally planned on applying to your mortgage as extra payments (since they didn't take out $1400 but $1200). So the real question is, how much money could you have saved by correctly applying it then, versus how much you could save if you applied it now. That's the interest you missed out on saving. And to calculate that, use the spreadsheet I linked to in my earlier post.

 

[pgwenthold]

None. Interest is accrued monthly, it doesn't matter when you pay it, and even your regular payments are always applied partly to the principle (unless you've got an interest-only loan). Because you didn't pay more during that period than your normal payment, you get no savings.

I guess if the interest accrues daily but also compounds, then it shouldn't matter how that payment goes.

The annoying thing about it, however, is that the bank transfer was clearly indicated as a Principal Payment, so it should have been happening automatically (going to principal). I think there is/was a flaw in their software. Apparently, I must be the only one doing this (paying extra via a scheduled on-line transfer out of another account) because everyone at the bank who has my mortgage knows who I am and that I am doing it.

 

[Uncayimmy]

Maybe I'm missing something here, but it seems to me to be rather simple. On a mortgage your monthly interest payment is monthly interest rate multiplied by the principal. That comes out of your payment, and the rest is applied towards the principal. The next payment a little less goes towards interest and a little more goes towards principal.

So let's say on January 1 you paid an extra $200. That should have knocked your principal down by $200, which means for the month of January you were paying interest on $200 more than you should have. On February 1 you do the same thing. That means in February you were paying interest on $400 ($200 + $200).

The monthly interest is 0.004895, which means it cost you about a buck the first month ($200 * 0.05875 / 12). The second month it cost you two bucks ($400 * 0.05875 / 12). The third month it cost you three bucks. The four month it cost you four bucks. All told that's $10. When they apply that $800 towards the principal, you're "all caught up" so to speak, so you won't ever be paying interest on that money again. You're just out that $10. You'll get the benefit of the extra payments for the life of the loan after that.

You didn't ask for financial advice, and I apologize for being presumptuous, but you must remember to compare your mortgage interest rate against all the other rates. If you're carrying any other debt at a higher rate (credit cards, car loan), put the extra $200 towards that until it's paid off. What confuses people is that they think about the savings of that $200 over 20 years or whatever, as you can see from the above, but what really matters is the interest rate over the time period involved. It's better for that $200 to go against a car loan at 10% for the next three years, then put the $200 towards the home.

As for you home equity line of credit, don't count on it. Google HELOC Freeze. If you can't refinance your home due to the housing crunch, then don't be surprised if they reduce your line of credit or cancel it outright. You may want to pull the money out now.

You also have to look at deposit accounts. One of my clients (website and marketing) is www.Bank1440.com. They have a program where ordinary checking (up to $25K) earns 4.01%, and it was 5.01% for a long time. You can get CDs at similar rates. That's less than your mortgage, but the money is liquid. If you need the money, you don't have to pay the bank to get it back like you do with a home equity loan. It all depends on the rates and tax advantages of course.

If you pay an extra $200 for five years, that's $12,000. If you had a high yield checking account, you'd be paying 2% more (so to speak) putting it into checking than putting it into your home as additional principal. If you then borrow that $12,000 at 6% interest for five years as part of a home equity loan, are you actually better off than if you just wrote a check for $12,000?