Regular mortgage payments are set up such that you pay the same amount each month but the breakdown between principal and interest changes every month. You first pay the interest calculated from the previous balance. The remainder then goes toward the principal. Then next month the interest portion is calculated from the reduced principal. You pay a little less in interest and a little more in principal. It goes on and on like this until the mortgage is paid off.
All the mortgages I’ve had make the monthly payment due on the first day of each month but they also give you a 15-day grace period. As long as you pay within the grace period, it’s as if you paid on the first. It doesn’t make any difference whether you pay on the 3rd of each month or you pay on the 12th. I chose to have the bank auto debit on the 7th. That gives me a buffer within the grace period. In case something goes wrong, I can still make a payment manually before the 15th.
After the new tax law passed late last year, I resolved to pay off my mortgage as soon as I can. With the new $10,000 limit on deducting state and local taxes and the expanded standard deduction to $24,000 for married filing jointly in 2018, I don’t get any additional deduction for the mortgage interest any more. I will switch to the standard deduction.
This means making extra payments that apply to the principal. If I make the extra payment together with my regular payment on the same date in different months, obviously the sooner I make the extra payment, the sooner the reduced principal lowers the interest for the following months. For instance if I have the money already, paying on June 7th is better than paying on July 7th in terms of lowering the interest charges.
Is that true within a month as well? If I have the money for the extra payment only on the 25th, is there any advantage in rushing it before the end of the month versus waiting until the regular payment in the following month? If I have the money on the 5th, is it better to pay on the 5th or is it better to wait until the 25th?
The answer, at least for my conventional mortgage serviced by Chase, is that it’s better to wait toward the end of the month but still make it within the month. I suspect this is the case at other banks as well.
I made several extra principal payments on different dates this year. From my mortgage account records, I saw that an extra principal payment made late in the month reduced the interest due in the following month by the same amount as an extra principal payment of the same size made earlier in the month. Just like the date for a regular payment doesn’t matter within the 15-day grace period, the date for an extra principal payment doesn’t matter within the month.
If you have the money near the end of a month, try to make the extra principal payment before the end of the month and not let it slip to the following month. You will stop the interest for a full month by the difference of a few days. If you have the money at the beginning of a month, when you wait toward the end of the month (but not cut too close and pass the end), your money can earn a little bit of interest in your bank account.
This is only true for mortgages. Car loans and student loans don’t work this way. In those loans the payments go strictly by the days. An end of a month doesn’t make any difference. The sooner you pay the sooner the interest stops.
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Why did the new tax law give you incentive to pay off your mortgage sooner?
Harry Sit says
Because the standard deduction increased to $24,000 for married filing jointly and the deduction for state and local taxes is capped to $10,000. When our other deductions including the mortgage interest come to less than $14,000, we are better off taking the standard deduction. When the mortgage interest doesn’t give us any extra deduction, the effective cost of having the mortgage goes up.
We weren’t itemizing anyways and are paying ~$3000/year in mortgage interest these days, so the new tax law doesn’t affect my interest in paying off the mortgage at all. We just refinanced to a 5/1 ARM with a 10 year amortization, so we don’t have too much time left now. We’ll likely pay it off within 5 years.
I have found that if I make an extra mortgage payment on say the 30th of the month, I still save the interest from the balance reduction, so in that sense, it does matter if you make the extra payment on the 30th or the 2nd. Even for the amount of interest our checking/savings accounts pay, I prefer to make the extra principal payments at the beginning of the month we budgeted for them because I like to check my monthly obligations off.
Harry Sit says
Thank you for confirming it also works the same way for your mortgage.
Make sure your extra payment indeed goes 100% to principal.
If you send the same amount as your regular payment, the bank may consider it to merely be a prepayment of your next month’s payment (with the normal mount of interest and principal).
This happened to me, and I didn’t discover the issue until 6 months later and it was a mess for them to recalculate everything.
Fortunately it was a local credit union and they were willing to fix it. Big banks might not.
For standard mortgages interested is only capitalized12 times per year (not daily like HELOCs and credit cards). I also had a mortgage with Chase and found that if I prepaid my loan right before the month end statement was generated, then interest that month would only be calculated on the outstanding principal balance at the time the statement was generated. Therefore, I waited until the very last day to make a payment (I think it might have been the last day of the month, but I can’t recall exactly).
It was not as much for the float income on the prepay amount as it was insurance in case I needed the funds for an emergency or something higher priority that month than prepaying my mortgage.
I don’t know the particulars of your case, but assuming you are extra-paying $5,000 a month, and assuming somehow you get 8% interest, that 20 days of holding onto your money before paying the extra payment gets you $21.90, or about $263 per year. Money is money and I would never want to throw away any money, but if you are actually making a smaller payment than my assumed $5,000, and/or if you are actually getting less than my assumed 8% interest, your interest on your money for 20 days is basically nothing. I have gotten a little discouraged from reading finance blogs because a lot of times they focus on math that turns out to be relatively trivial rather than focusing on what matters in living one’s life. If you have extra money, send it in. Paying off your mortgage is not some sort of game where you prove you can operate a calculator better than the mortgage banker at CHASE. Sorry, did not mean to come across as a jerk, but really, the finance blog world is full of this kind of non-advice that basically comes down to clever, but very trivial, math games.
I think his point was made in his final paragraph:
“It was not as much for the float income on the prepay amount as it was insurance in case I needed the funds for an emergency or something higher priority that month than prepaying my mortgage.”
So, the better reason to wait until the last minute was in case he found another need for the cash.
Personally, if I was that concerned about needing the extra payment for an unexpected reason, that would be a blinking light saying “emergency fund is insufficient”
Harry Sit says
The difference is small relative to the payment but when you are making large payments, the difference in dollars can be meaningful. I wouldn’t throw away $263. I paid off $100k since the beginning of the year. I’m paying another $150k before the end of the year. Making sure the payments hit before the end of the month and not slip to the beginning of the following month makes enough difference to me.
Stephen L. Nelson CPA says
Can I just make this comment as a tax accountant?
I like this idea of paying off the mortgage and then just “taking” that $24,000 standard deduction.
It seems like a pretty darn good deal. In many situations, in fact, I kinda think you’re essentially earning a pretty decent, tax-free risk-less rate of return… also easing paperwork and bill-paying.
I think it doesn’t matter at all.
so the purpose of extra payments on the principle balance of the mortgage forces a re-amortization on the interest you have to pay. you end up shaving off chunks of interest payments and therefore shortening the length of the loan time.
it’s worth keeping more off your money if you can, the tax stuff is probably a bonus.
(from a home owner and rental property owner)