My son has a closing on his first home tomorrow, September 6, 2013. I requested a copy of all legal documents for our review. While going through them this evening, I was unpleasantly surprised to find the following sentence in the Promissory Note regarding the prepayments:
"...The Note Holder will use my Prepayments to reduce the amount of Principal that I owe under this Note. However, the Note Holder may apply my Prepayment to the accrued and unpaid interest on the Prepayment amount, before applying my Prepayment to reduce the Principal amount of the Note."
The loan is made that there is no prepayment penalty. However with the sentence in bold above, I believe the bank reserve its right to charge interest to any prepayment amount that my son makes in the future. My son is determined to pay his 15year loan for about 5-6 years in order to save from interest on the principal.
My question to you you is, if I understand properly that under the condition the bank institutes, my son will not be able to save anything on his interest even though he decides to pay his loan in advance.
Thank you very much.
2 Answers from Attorneys
Your son's closing attorney should read that provision in the context of the loan terms, but I do not see that it should significantly impact anything. It sounds like you probably know much of this, but interest typically accrues and is paid with the next monthly payment. So, step by step, unless it is a rare exception where he will be credited six days interest, your son will pay interest for the balance of the month of September at closing tomorrow. His first mortgage payment will be due November 1, which will cover interest for the month of October. The December payment will pay interest for the month of November. So, accrued and unpaid interest would be a number of days on the prepayment amount. So, say on November 15, he pays an extra $1000, which would reduce his principal. The lender would be protecting its right to collect the interest that would already have accrued on that $1000.00. That should be minimal. He will then want to pay attention to how the next payment is applied. It is recommended that he make prepayments by separate check, not an addition to the monthly check, and clear designate it on the face of the check. In my experience, mortgage companies are poor at applying amounts outside the ordinary amortization. He should monitor the account month by month.
I agree with Mr. Repay. All this clause says is that IF there is accrued and unpaid interest at the time that a prepayment is made, the lender can first apply the prepayment to that unpaid interest -- meaning essentially that your son should ALWAYS get a "payoff letter" from the lender so he will know exactly how much is needed to pay off the loan early. This is standard practice -- otherwise your son could make a payment just shy of the amount owed and the loan would NOT be released. It is a way of protecting the lender from underpayment. This alone is NOT a prepayment "penalty" of any kind.