Pay Down or Pay Ahead? It Can Be Confusing

Years ago I learned a lesson I won’t have to learn again. It was that poignant. It was during a time when mortgage interest rates took a nosedive and we benefited by refinancing our high-rate mortgage.

The transaction closed in late 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 balance 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 confused customer service rep was kind but hardly apologetic when she explained that 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 balance was good for us because every penny of that unscheduled payment went to reduce the balance—no interest was due until October. That was profitable for us, but not for the lender.

By reducing the principal at the beginning of the loan, we would go on to save more than $4,000 in interest and cut three months off the term, which we did and oh what a happy day that was!

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. 

This doesn’t mean that it is never wise to pay ahead on a mortgage or other kind of debt. Here’s a quick overview:

Pay down the principal

When you pay down the principal, your loan balance goes down. But you must still make the next scheduled payment. Let’s say you make your regular mortgage payment in April plus three extra payments. Your plan is to pay off your mortgage ahead of schedule so you can avoid paying a load of interest. You enclose a note that the additional payments are to pay down the principal balance. You will still have a payment due in May and June and July, as scheduled

Pay ahead the payments

Now let’s say that the reason you are sending those three extra payments is that you are going to Europe for the summer and want to pay your bills in advance before you leave. In this scenario, you want to “pay ahead.” You’ll be back before the August payment is due.

If you are not very clear how you want the extra funds handled, the lender might assume you want to pay down the principal balance. You head off on your trip assuming you’ve made your mortgage payments for the time you’ll be out of the country. You arrive home only to learn that your home is in foreclosure for failure to pay.

Some lenders will simply return additional payments if it is not clear how they are to be handled. Others automatically apply additional sums to future payments, defaulting to the lender’s benefit.


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Overexplain then follow up

When you make prepayments on your kind of financial obligation, always enclose clear instructions. And make sure you also abbreviate your instructions on the check or payment advice itself. But don’t leave it there. Follow up in a couple of weeks to make sure the transaction was handled per your instructions. And don’t be surprised if your lender is not easily persuaded to “pay down.” Or failed to “pay ahead,” as the case may be. Don’t give up.

And by the way, unless you have a prepayment penalty clause in your terms and conditions, you have every legal right to “pay down” your mortgage, student loans or credit card balance provided you are not in default.

Question: Are you working on paying down your mortgage? How is that going for you? Share your experience in the comments area below. 


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First published: 11-06-12; Updated: 4-16-19

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13 replies
  1. MaryBB
    MaryBB says:

    Yes! Not only did i refinance to reduce the amount of interest I’ll be paying, but I’ve also been working with my bankers to make additional principle-only payments every month.

    Reply
  2. Margaret
    Margaret says:

    My husband and I have always disciplined ourselves to payoff our mortgage early. The first mortgage we ever took out was a 30 year. We always paid a little extra toward the principal, but we also refinanced twice, cutting our interest rate in half. When we had to move, we only had 10 years left to pay on our home after having lived in it only 10 years! Not bad if you ask me. We are currently working on the mortgage for our 2nd home which we have lived in for 3 1/2 years, and have already refinanced it shaving off 2% from the original mortage and are continuing to pay extra toward the principal each month. We don’t consider ourselves financially sauvy; we just hate owing anyone money and hate giving our hard earned money away to a big institution.

    Reply
  3. Rose
    Rose says:

    We have a loan through HSBC for a second mortgage. We pay 13 payments a year, however, they will not allow us to pay ahead on the principal. We have contacted them several times to get this changed, but they won’t. Has anyone else have had this happen? They put the money in something called “unapplied funds”.

    Reply
  4. Beck
    Beck says:

    We paid about $2.50 a month for an equity enhancement program the bank took out a half payment every 2 weeks. Thus making principal payments earlier in the month then the regular date plus an additional full payment per year since there was 13 full payments made each year. Eventually we added more and more to each half payment. The payments were automatically deducted from my checking account then we got a lump sum together and totally paid it in full It is great not to have a mortgage. That amount – some of it went then to save for the kids college which came in handy. As soon as they both graduate it will be put in for retirement. I had worked for a bank that had trouble splitting payments that came in so I didn’t mind paying the $2.50 a month for the service even though a lot of experts say do it yourself I didn’t want the hassle. So we paid off our 15 year loan in 7 years. What a relief.

    Reply
  5. miss judi
    miss judi says:

    Howdy Mary! I don’t know if my small loan works the same as a regular mortgage-I have a little trailer house. Soon after I moved in, with a loan for $10,000, I started working on how to do the ‘principal only payment’. Some months have been smoother than others. Sometimes when I call to make this ‘pop’, the computer system asSumes that I’m making a loan prepayment. But aMazingly!! While living on unemployment and student loans, I have it pared down to just over $2,000! In 3 years! I am Soo Blessed! I will own my little trailer before my student loan payments start!!

    The tricky part is that the loan payment is taken out automatically, and so I need to call on That day to maximize my ‘pop’…but some of the folks at the bank have to be conVinced I can do this ;-)…it is Well worth the effort!

    Reply
  6. Vonnie
    Vonnie says:

    We pay our mortgage online and have it set up to pay an extra $100 per month that goes directly to principal. That means that we will pay the 15-yr loan off 18 months early and save us about $15,000 over the life of the loan.

    Reply
  7. KellyJMF
    KellyJMF says:

    When I left college, my student loans had a 6-month period before payments needed to start. Since I had a job, I started making payments right away in case there came a time when I didn’t have enough to make the payment that month. It was a huge help when finances got tight so I could always keep my obligations current. Later when I got a better job, I started paying extra each month and saved a nice chunk of interest just rounding up the payments a bit.

    Reply
  8. Jenn
    Jenn says:

    My mortgage lender’s online payment screen includes a field specifically for extra principal payments. So far so good. Even though I can only afford to pay an extra $5/month on my mortgage, that small amount reduces my total payments by 1-2 over the life of the mortgage.

    Reply
  9. Naomi W.
    Naomi W. says:

    Ever since we refinanced our home for the first time 9 years ago, we have rounded off the payment to a higher number, adding about $150 to our payment each month. Just this little bit of extra principal adds up. A friend told me what I should have done is add the same percentage to my mortgage as what my employer gives me as a raise. So if my raise is 5%, then up your house payment 5%. All of the additional amount is principal. Do this every year! Boy will that help pay the mortgage down!

    Reply
  10. lynnemp
    lynnemp says:

    My home is now paid for but we went through some very rough times. The original loan was taken over by a bank, and then things went sour. Our payments weren’t credited etc. I began making the payments in person at the local branch and continued to have problems. Each month I paid the regular payment plus an additional amount to be credited on the principal. Even though the teller assured me it was entered as instructed (on my papers & check & personally) each month my statement would be incorrect. I’d have to go back to the bank and get it straightened out. This went on for several years. I finally had them call the main office & I talked to a manager and was assured that there would be no further “mistakes”. There weren’t. This was especially important because we bought our home on a mortgage rate that was adjustable & it kept going up, up & up. Fortunately by pre-paying even just a small amount each month, we were able to chisel away the principal & pay it off early.

    Reply
  11. Dar
    Dar says:

    We bought our first home in 1976 for $31,500, borrowing $28,300. After living there eleven years (and paying a little extra on the principal), we only reduced the amount owing by only $3,000! Fast forward to July, 2009. We purchased a home with a mortgage of $131,000. Since we are entering our 60’s, we decided to pay extra on the principal each month to pay the house off in less than 30 years. Our lender allows us to make online principal only payments by transferring money from our checking account. As of November, 2012, we only owe $27,870! I predict, Lord willing, we’ll have the house paid off in less than a year. Paying extra on the principal definitely pays off!

    Reply
  12. kaetra
    kaetra says:

    Just when you think you know the answer (e.g. pre-pay the principal) they change the question (e.g. “What does pre-pay mean?”)!

    Reply

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