not allowed to prepay mortgage

[kimmarg]

We have 26 years left on a 30 year mortgage. Outstanding balance around $134k @3.625%

Since we got the loan we have paid half a mortgage payment every 2 weeks. These payments were set up as "regular payments" and went automatically.  This means after almost 4 years we are about 3-4months ahead in our payments with the next payment not due until Oct.

Last month I noticed the payments started going through as 'principle only'. Great for the loan balance but not what I expected. I called the bank and they said due to some rules I do not understand, potentially involving escrow we can no longer prepay. I guess this is because our mortgage payment is recalculated every Oct (taxes and insurance change for escrow, payment is fixed). Since we are now paid through Oct they won't accept anymore payments until they know what our new payment is. But even then they said we can't keep paying every 2 weeks. This is a local bank and I'm very happy with the service so I'm not interested in switching banks.

What is the easiest way to effectively pay every 2 weeks? transfer to savings every 2 weeks and then autopay out of savings every month? Should I let the excess build up in my account?

There are two reasons I want to pay every 2 weeks:
1) I get paid every 2 weeks. This means my pay date changes every month. I am not able to pay a full mortgage payment on one paycheck so I need to make sure the timing is correct. So by paying half every payday I know it will always clear and I don't need to worry about the times of the year when payday is a day or two after the mortgage is due.

2) I consider being paid a few months ahead part of my 'emergency fund'. I keep cash on hand for several months of living expenses and since the mortgage was prepaid for several months that adds to my emergency buffer.

What to do?

[Murse]

If it were me I would start a "house fund" in a vanguard index fund (taxable) and everything you put in there have earmarked for the house. I would only pay the minimum each month. Once the balance of the index fund is >your mortgage (-taxes) then you can make the decision on wether to pay it off or not. At an interest rate of 3.625 I think it's a no brainier to let it ride but that is just my opinion and you need to weigh your own options.

It sounds like you have a variable interest rate loan, I would also consider getting it fixed.

[waltworks]

Something does not make sense here. Your monthly payment (or biweekly, or whatever) can indeed only be prepaid (ie, paying November's payment in September, or whatever) until the new escrow amount is calculated.

But that's not a problem, because if what you care about is paying down the loan, you actually want to be paying *the principal in advance but not the escrow*. Imagine, for a moment, that you could keep making prepayments - your escrow balance would grow enormously, and that money would simply be sitting in the account, gaining zero interest, while your mortgage balance would be higher by the same amount, on which you *pay* interest.

In effect, you would be giving the bank an interest free loan, while paying off your mortgage more slowly. Really not a good move. Pay your extra principal and do your happy dance, assuming that paying down the loan is your main goal here.

-W

[Tjat]

this is very confusing to me as well. What's the point of prepaying the mortgage if the excess doesn't go solely to the principle? Interest is calculated based on your remaining principle balance, so if you prepay interest, you're literally throwing money away.

Another concerning aspect is the need to pay your mortgage on the same schedule as your paychecks. Is your concern that if it isn't immediately taken out of your pay, that the money just won't be there later on when the mortgage is due? Having the restraint to not spend money just because it is in your account is a key tenant of MMM.

[kimmarg]

Something does not make sense here. Your monthly payment (or biweekly, or whatever) can indeed only be prepaid (ie, paying November's payment in September, or whatever) until the new escrow amount is calculated.

But that's not a problem, because if what you care about is paying down the loan, you actually want to be paying *the principal in advance but not the escrow*. Imagine, for a moment, that you could keep making prepayments - your escrow balance would grow enormously, and that money would simply be sitting in the account, gaining zero interest, while your mortgage balance would be higher by the same amount, on which you *pay* interest.

In effect, you would be giving the bank an interest free loan, while paying off your mortgage more slowly. Really not a good move. Pay your extra principal and do your happy dance, assuming that paying down the loan is your main goal here.

-W

I actually do get interest on the escrow, although I'm sure it's much lower than the interest on the loan. Normally once a year when they recompute the escrow I get a check back for the excess as the escrow is not allowed by law to be kept. I put that amount as a principle payment on the loan at the end of the year.

[kimmarg]

this is very confusing to me as well. What's the point of prepaying the mortgage if the excess doesn't go solely to the principle? Interest is calculated based on your remaining principle balance, so if you prepay interest, you're literally throwing money away.

Another concerning aspect is the need to pay your mortgage on the same schedule as your paychecks. Is your concern that if it isn't immediately taken out of your pay, that the money just won't be there later on when the mortgage is due? Having the restraint to not spend money just because it is in your account is a key tenant of MMM.

I guess I find it much easier to pay it on the same schedule as my paycheck because I can put it on auto pay. Otherwise I keep my checking account balance low enough that it could potentially not clear. I guess maybe I should make $1k my 'zero' for checking and then I could not worry. It's a bit of a mental game, as soon as my paycheck comes in I pay the 1/2 mortgage and a bunch of auto transfers to my savings automatically. This amounts to about 60% of the check. I then pay any bills, utilities etc. The remaining is what is available for groceries, and any other spending. If it's not there I don't spend it thus I like to squirrel it away as soon as it arrives.

[SwordGuy]

See if you can prepay your escrow each year.  Then your payments would stay the same and you could pay ahead as much as you like.


Then again, you are just giving them money if the extra you are paying isn't going to principal...

[nienajadly]

I get paid every 2 weeks also.  I have a sub-savings account that I move 1/2 of the mortgage payment to when I get paid, then move it back on the 2nd payperiod when the mortgage is due.  It's set aside and I always have the money for the payment by the due date.

[Kwill]

I guess I find it much easier to pay it on the same schedule as my paycheck because I can put it on auto pay. Otherwise I keep my checking account balance low enough that it could potentially not clear. I guess maybe I should make $1k my 'zero' for checking and then I could not worry.

One thing you could do for peace of mind is set up a line of credit on your checking account if your bank or credit union offers this. It's like a loan that comes into effect only if you overdraw your checking account. I've had this for something like 15 years maybe and have only used it a few times. But those few times, it was really nice to just pay 50 cents or less for the interest on the day or two that I was overdrawn rather than have a check not clear because the amount was slightly off. My credit union doesn't charge any fees for this other than interest, but you'd want to check with your bank since some have fees.

[MDM]

I guess maybe I should make $1k my 'zero' for checking and then I could not worry.

Good idea!

[arebelspy]

I guess maybe I should make $1k my 'zero' for checking and then I could not worry.

Relevant thread: http://forum.mrmoneymustache.com/ask-a-mustachian/your-checking-account-balance/