How do banks determine when my monthly payment obligation is met?
For purposes of this discussion, let’s say that that my monthly payment is $900 due on the 1st of each month and my APR is 6% with an outstanding balance of $150,000 on 1/1/09 with the first payment due on 2/1/09. Also, the loan has principal curtailment.
I’m trying to figure out the typical way a bank would determine when the payment due on 2/1/09 has been met. It can’t simply be when I’ve paid a total of $900 before 2/1. If I pay $450 on 1/15 and 2/1, then with principal curtailment the entire payment on 1/15 went to principal and $450 on 2/1 won’t be enough to cover the interest accumulated (~$764).
Is any payment less than the payment amount considered a principal curtailment payment and therefore not applied towards my monthly payment? So even if I’m a penny short will the bank consider that just a principal payment and not advance the due date?
This would depend on how your loan was written. Generally, any payment made in advance (like your 1/15 payment that isn’t due until 2/1) will all go to principal. However, you will still have to make the full payment on 2/1 (which will go mainly to interest and some to principal). As another example, suppose on 2/1 you pay more than $900, then the amount over $900 will go to shrinking your principal. But you should check with your lender.
My mortgage bank added my payments once a month, on the first day of the month, subtracted the interest due and the rest went to principal. They certainly were not computing interest day by day.
They probably are computing interest day to day, actually. That is why principal curtailment works. Otherwise there really wouldn’t be a benefit to making a principal payment in the middle of the month.
nivlac - I realize any money over $900 would go to principal if I make my payment on 2/1. But what happens if I pay $899.99 on 1/30 and then $0.01 on 2/1?
Put in the usual disclaimers about speaking with the lender directly, etc. I’m not asking about a specific situation, I’m asking in general how banks would determine when a due date should be advanced. I would think there is a “standard” way this is calculated and I’m just wondering if anyone knows what that is.
I just told you in my case it makes no difference. On the first (or fifth or whatever) of the month they add up all payments received, subtract interest owed and the rest goes to principal. Do you need me to draw an explanatory diagram?
My bank computes interest continuously.
Also, they recompute the interest on the data the payment was received. If I send it in early, I get a slight reduction in interest compared to paying on the 1st. It took my a while to figure out why my extra-payments spreadsheet was always slightly off, and this is the reason.
No, no diagrams are necessary. It still doesn’t explain how the bank determines when to advance the due date (move it from 2/1 to 3/1) but I think in this situation it seems pretty clear that happens when you’ve paid a total of $900.
But what happens in your situation if you don’t pay on 2/1? On 2/1 you owed ~$750 in interest (1 month at 6%/year), but that assumed a principal balance of $150,000 for 1 month. In March, had you made the payment on 2/1, I assume you’d have an interest due of ~$749 (1 month at 6%/year on a $149,850 balance). If you don’t make your 2/1 payment, is the interest owed still based on the original amortization schedule or is it recalculated since the principal didn’t go down on 2/1?
beowulff - I think most loans work this way (simple interest) but I’m still not sure how that plays into figuring out when the due date will advance. As you said, if you send in the (full) payment a few days early you pay less interest since you have fewer days at the higher principal. But what happens if you send in less than a full payment mid month and then the rest at the end of the month?
I think pretty much all mortgages have the interest calculated daily, so there’s no “applying towards the principal” or “towards the interest” - any money paid in is credited that day, reduces your balance by that amount, therefore from then on the interest you’re charged is less.
What it gets down to here, is the question of what triggers your mortgage company to consider your 2/1 due date as “paid.” If you pay the same amount as your regular payment on 1/15, will they then consider that you’ve made your 2/1 payment, or will they think it’s simply that you’re paying extra and still intend to pay again by 2/1?
I don’t know the answer, but I wanted to clarify what the question actually comes down to.
But then when is the interest paid? If any money paid is applied to principal, then no money is ever paid to interest. Also, sailor had indicated his loan is on an amortization schedule instead of interest accruing daily. Those due exist, but my question isn’t really concerning those types of loan.
Yes, that is the crux of my question. With principal curtailment (paying extra) it isn’t at all clear to me when my 2/1 obligation has been met.
I am not a banker, but this is how it was explained to me by someone who was:
Think of each monthly interest and principal payment due as being associated with a bucket. When a payment comes in, it is assigned (credited to) the oldest unfilled (including not fully filled) bucket.
Your monthly P&I payment is due on the first of each month, with no late fee if you pay by the 15th (the 15th is standard in my experience, but some banks may have a different grace period). You send a payment to your bank. It looks to the oldest bucket available and fills that as much as possible. If your payment is larger than it takes to fill that bucket, then it puts the balance in the next oldest. Interest is satisfied before principal, and I think most banks satisfy late fees before either interest or principal. If you send more than it takes to fill all the outstanding buckets, what they do with that extra should be spelled out in your loan agreement. If it goes to principal, your mortgage re-amortizes and the amount of interest you owe the next month is less than it would have been.
I do not know how close to the due date a prepayment has to be (and by this I mean a payment received prior to the due date) to be considered as satisfying the upcoming payment if no instruction has been provided. This probably varies from bank to bank. But most if not all mortgages come with coupon books or similar, which instructs the bank as to which payment (date-wise) you are making. By using these you should be able to avoid most misunderstanding as to which payment you are making.
Again, the general rule in my experience is the outstanding late fees are paid/satisfied first, then interest then principal. If, for example, your 2/1 and 3/1 payments are both outstanding, along with a late fee because 2/1 is past the grace period, any payment you make will be applied first to the late fee, then interest due 2/1, then principal due 2/1, then interest due 3/1, then principal due 3/1. If you are past the grace period for 3/1, then that late fee is satisfied before the P&I. However, this should be spelled out in the loan documentation, and your particular loan may different.
Finally, if you get too far behind, that may trigger default terms, which will also be spelled out in your loan documentation.
As KittenKat says, any payment you send in goes to penalties first, then to interest and then to principal. At that point you start calculating interest again. But the fact that interest and payments are computed daily does not change the fact that you have to redeem principal at a certain rate which can easily be calculated.
Sorry, let me clarify that, because I used the wrong word.
The mortgage company doesn’t keep separate tallies of your principal and interest amounts - they only keep your outstanding balance, and interest is calculated on that daily. Any payment you make reduces the balance by the payment amount. Since interest is computed daily, the amount you reduce it will make it start accumulating less in interest charges than it would have without the payment.
You can’t make a payment and have it just apply towards the principal, because that number is not kept anywhere separately. Payments subtract from the balance of the loan.
That is correct. In my prior post, when I said principal, I meant the outstanding principal, i.e., the *remaining balance *.
It depends. If you had mailed in the $899.99 with your 2/1 payment coupon, then you’ve not made the full payment and some (miniscule) extra interest will accrue. You may also have violated the loan agreement. If you’ve just sent in the $899.99 with no explanation, it will go towards reducing your remaining balance, but I think you’ll still have to fork over $900 on 2/1. Then, of course, you’ll have to make a phone call to the lender to explain the intention of your $899.99 payment.
Thanks for all the responses. This really isn’t an actual scenario as I know what my bank does and I’m curious what other experiences are.
I used to actually write software that does all these calculations, but the way we did the payment applications is different than the way my bank is doing it, which is why I asked if anyone knows of the “typical” way.
As KittenKat pointed out, there are different buckets for different costs and those get satisfied in some order as determined by the bank. If they didn’t have separate buckets for interest and principal they would be charging interest on interest and that isn’t allowed.
With my bank, if a small payment is sent in mid-month they will apply it to principal and not take out any interest due. I still owe the full payment on 2/1. If I send in almost a full payment, they’ll just hold the money until more money is sent in and a full payment can be applied.
In my case, any payment that goes strictly to principal curtailment won’t help satisfy the next payment obligation. I have no idea if this is typical or not. Like I said, my experience with the software I wrote was different.