Pay Ahead or Pay Down? It Can Be Confusing

Recently we refinanced our mortgage. The transaction closed in August with the first payment due in October. Rather than take a month off from making a mortgage payment we made an unscheduled payment in September to reduce the principal right off the bat. We sent a letter with the payment and wrote “Principal Prepayment” on the check.

A few weeks later we got a statement showing that the payment had been credited to the October payment, not to pay down the principal as instructed. The woman in Customer Service said someone must have assumed that we really wanted to “pay ahead” rather than “pay down.” It took a little persistence to convince her to the contrary.

Applying that payment to the principal was good for us, but not profitable for the lender. By reducing the principal at the beginning of the loan, we will save more than $4,000 in interest and cut three months off the term. On the other hand, applying it to the October payment would have put almost the entire amount into the lender’s pocket in the form of interest.