Prepaying Principal - Complicated
When prepaying extra principal towards a weekly or biweekly payment mortgage it does not matter whether the prepayment falls on the payment date or between payment dates. The interest factor used to calculate the interest for a weekly or biweekly is already based upon the exact number of days between payments.
When prepaying extra principal towards a monthly payment mortgage there is no need for concern as long as the prepayment coincides with the scheduled payment.
If the prepayment is in mid month, the potential exists for a lender to use different methods of prorating interest calculations. The blended monthly payment, fixed rate mortgage (FRM) that most people are aware of is based upon a constant interest factor each month. Because of this constant interest factor, the amortization mathematics implies that an average month has 30.416666 days. If you had a 30 year FRM at an annual interest rate of 12% with monthly compounding the monthly interest factor would be 1% or 0.01 each and every month until the loan was paid in full.
You have a 12%, monthly compounding, open mortgage and decide you are going to pay extra principal 10 ten days into a 31 day month. One method of calculation is as follows. The interest for the ten days would be,. (10/31) x (.01) x (balance owing after your last payment). You would owe that 10 days of interest interest first, then you would make the prepayment and reduce the balance to Y. Twenty one days later your regular monthly payment is due and now the interest due is based upon (21/31) x (.01) x (Y). This is one of many methods. Which method your lender uses is up to their discretion and that is why the 365 day year, exact day monthly interest factor is popular.
Non-Scheduled Prepayments in a 365 day Schedule
The MORTGAGE2 PRO program automatically uses the exact number of days in the amortization SPREADSHEET schedule and reverts to a “365 day year exact day method” inside the SPREADSHEET the instant an extra date is inserted between payment dates. This method has become popular in North America because it is simple to verify and avoids potentially confusing prorating methods, even though the effective interest rate is slightly greater
The CALCULATOR above shows an example for the standard calculation in the 360 day mode. Notice the interest portion of the first payment is $1000 (which is 0.01 x 100,000) and the interest portion of the second payment is 999.47 (which is 0.01 x 99,946.78 = 999.47 to two decimal places). Do not be alarmed that the Calculator interest and the Spreadsheet interest above are not exact (215,973.82 vs 215,974.09). This is due to rounding as the SPREADSHEET is 300 single calculations and the CALCULATOR is one calculation using a formula.
By clicking on the yellow pencil on the toolbar, the green line was inserted into the SPREADSHEET below;
then by clicking on the Date cell on the green line the second date of 07/06/2002 was changed to 07/16/2002 as shown below;
A $10,000 prepayment is then entered in the prepayment cell on the green line as shown below;
and the schedule is automatically recalculated and up to date. The balance is $89,691.84 on September 6, 2002.