Prepayment penalty and interest arrears

[Daniel Mina]

Hey All,

I have a question about prepayment on conventional loans. The mortgage loans I'm currently after all state "no prepayment penalty." Say I am a few years into my mortgage and I believe I can pay a little extra on top of my normal monthly payment. If I make my normal payment of say $1500 on the normal due date of the 1st of the month and I decide to pay an extra $1000, this means that $1000 should all go to principal correct? Of course this is assuming no sneaky unpaid interest clause is in the loan despite a "no prepayment penalty" statement.

My second question is this:

If I make my normal payment of $1500 on the 1st and I decide to pay $1000 on the 15th of the same month, the lender would bill for interest in arrears (interest accrued from the 1st-15th) before directing the rest of the $1000 to principal right?

I just want to make sure I am understanding this concept of arrears correctly and to make sure that this is normal when "no prepayment penalty" is stated. 

Thanks in advance,

Daniel

[James C.]

Daniel,

Conventional mortgage loans generally don't contain a prepayment penalty, as you have mentioned.

Generally, your best course of action is to send two separate checks, one for the payment, the second marked "Principal Payment", along with a letter stating it as such. I would not leave it up to the servicing folks to make decisions for you. Most are wonderful people, however, they are processing thousands of payments per day. They aren't in your head (thankfully) and it's better to make it clear than to "assume" what is going to happen. 

I can tell you, no matter what your individual docs say, and what you want to happen, it probably won't come out the way you think. It will get straightened out eventually, but you will be pulling out your hair in the meantime. Also, once a loan is screwed up in the servicing system, it has a tendency to stay that way. 

The concept of arrears generally comes into play when payments are not made on time. In this case, the older due penalties and payments are paid first, then any leftover applied to the more recent penalties and payments. It's not generally applied to current mortgages with additional payments coming in mid-cycle.

Hope that helps.

Good Luck!

Jim