Ok, I’m in the process of buying a house, and had a conversation with my loan officer that has me wondering.
Basically: how is “over payment” (sending money in excess of the monthly bill) handled? And (somewhat related) did I mess something up with my student loans.
The way I’m currently understanding it (and feel free to correct me):
I get the loan, a 30 year fixed rate. A monthly payment amount/schedule is set up based on the loan amount (170k), the duration of the loan (30 years), and the interest rate (not yet locked in).
I get my first mortgage bill. The fraction of that which is interest and which is payment towards principal is pre-calculated in the amortization schedule.
I pay more than the amount on the bill, reducing the loan principal.
The next month, I get my second mortgage bill. The amount going towards interest remains consistent with the original schedule, not the “actual” principal (which is reduced due to my extra payment last month).
This continues until the loan is paid off. At that point (assuming this is earlier than the original loan period), the bank does a “re-amortization”, determines how much extra interest I paid on the actual month-to-month principal, and refunds that money.
Is that refund part right? And if so, does that re-amortization apply to other long term loans? Specifically, I paid off my college student loans (which had a 10 year duration) in six years, but never heard anything from the lender about a re-amortization refund. Was there a hoop I missed jumping through? Is that money still out there for me to collect?
I’m wondering if I missed that magical “pay excess to principal” note on my payments, so I have a zero balance loan sitting out there with a next scheduled payment of $0 on August, 2008 (the end date of my student loan). Is there any chance I can call up the lender and get that excess (if any) back?
All normal disclaimers are assumed regarding any reply: you’re not a lawyer/accountant/loan officer, or you are but not in my jurisdiction, and I’m not your client. You’re not liable for any misunderstandings on my part or any consequences of my following any advice/information provided.
When you “over pay” a mortgage payment, the extra payment is applied towards the principal. The interest in each payment should be calculated on the remaining principal. So with each payment, the amount towards interest decreases while the amount that is applied to paying down the principal increases. By overpaying each payment, you can pay off your loan faster and also incur less overall interest. If, in your Step 4, the amounts towards interest follow the original amortization schedule, then you are indeed overpaying interest whenever you make an overpayment. At the end, you are owed money by the lender. They need to calculate the future value of the cumulative overpayments of interest, and pay that to you when you have paid off the loan. Frankly, with the way everything is computerized, I don’t see why the lender can’t charge you the correct interest on every payment. I can see the approach you outlined as perhaps necessary in the dark ages when calculations must be done manually.
What nivlac said. Your scenario falls apart at step 4. Having worked with (and written) computer programs to handle loan payments, I can tell you that interest is computed at the time the payment is received, and not on the amount shown on your original amortization.
Even if you don’t pay any extra each month, the interest applied to you loan will be different from your schedule, unless you pay on exactly the same day each month. If there have been 25 days since the last payment, interest on the outstanding balance will be less than if 34 days have elapsed since the last payment.
When the lender receives your payment, interest is calculated based on 1) the current principal balance, 2) the interest rate, and 3) the number of days since the last interest payment. This amount from your payment is applied to interest, and anything remaining is applied to principal. This give the new balance that will be used to compute interest next time.
Long story short, the amortization schedule you got from the lender (or calculated yourself) is only an estimate. When it comes time to make the final payment you need to contact the lender and find out the exact amount of the “payoff balance” including remaining principal and interest up to the date of the final payment.
Interest is charged according to the loan contract. In most such agreements, the interest is charged exactly as described in step 4. Of three such agreements that I have signed, all have specified that no interest will be refunded in the event of early payment. There is no possible way to predict the future pattern of overpayments, so the original amortization holds until you pay off the principal. It’s wise to contact the bank as you approach that point, so that they can calculate the final payment.
See, that’s why I was confused. The “interest calculated when payment received” makes more sense. Maybe the overpay explanation was meant more towards showing the overall reduction in total payment due to reduced interest, and the “payback” is was just the amount saved compared to sticking to the original payment schedule. And I probably confused the issue more with a bad phrasing of my question that led to the misunderstanding in step #4.
So is “reamortization” ever needed outside of an actual refinancing?
Typically the only time a loan would be reamortized would be if the borrower is having problems making payments and requests some relief from the lender. If the monthly payment is $150, but the borrower can only pay $100 per month, the lender will sometimes reamortize the loan with a lower payment over a longer time period.
You know, I could’ve swore Nametag’s post wasn’t there when I posted last night.
So there are loan contracts that stick to the original interest schedule and don’t repay any “extra”?
I guess I’ll just comb through the contract I get to see how my particular one is set up. I don’t have it yet (the seller’s bank is holding things up, since the seller is upside down on their loan), but at least now I know that this is something I need to look for.
Reamortization would also occur if you have an kind of an adjustable rate mortgage. Every time the interest rate is adjusted, the entire thing is recalculated, using the next interest rate, the current principle owed, and the time remaining on the mortgage.
My car loan is like that. If I pay extra, they reduce my minimum payment for next month accordingly. I don’t get out early unless I pay off the loan completely. 14 more payments to go!
My home loan OTOH I can make extra payments and pay off early. Just as a quick example: On my old loan over a 28 year period, it would save me something like $2.40 for every dollar I overpayed at that point. The calculations are kinda comlex and shift as the loan progresses but an extra $20 or $50 a month is immensely worth it in the long run if you can afford it. You will end up saving thousands in interest later down the line.
There is a variety of loan called a “rule of 78” loan. These loans are structured so you have to pay ALL of the interest, even if you repay early.
I believe it is not currently legal to offer rule of 78 mortgages. You’d be most likely to see them as loans for purchase of consumer goods, or at buy here pay here furniture places.
The “interest calculated when payment received” makes more sense. Maybe the overpay explanation was meant more towards showing the overall reduction in total payment due to reduced interest, and the “payback” is was just the amount saved compared to sticking to the original payment schedule. And I probably confused the issue more with a bad phrasing of my question that led to the misunderstanding in step