When making ‘extra’ debt payments, be sure that you understand the ‘policies and procedures’ that your creditors have implemented. Call your creditors and ask –
1. If I send in a payment amount that is ‘above’ my ‘minimum payment’ – how will that payment be handled?
This is a very important question. Certain creditors will ‘hold’ any amount that is above the minimum payment – and apply it as a ‘prepayment’ of the next month’s minimum payment. This is especially common with automobile companies and some mortgage companies. Remember, we want our ‘extra payments’ to go towards ‘principal’. We do not want to ‘prepay’ – we want to ‘pay off’.
2. If I want to send in more than my minimum, should I send more than one check?
This question relates to question 1. I always liked to make multiple payments per month to my creditors. On each and every ‘extra payment’ I would make a notation – ‘Please cash immediately and apply to principal’. Again, we do not want our creditors ‘holding’ extra payments and waiting to cash them. Also, I used FREE ONLINE BILL PAY to initiate extra payments. I never gave a creditor access to my checking account. In other words, all ‘extra payments’ were initiated by me, and not my creditors.
3. Is there a prepayment penalty associated with my loan?
If so, you need to get out your loan documents – prepayment penalties are usually associated with mortgages – and do you very best to understand every detail about the ‘penalty’. I have never had a ‘prepayment penalty’ associated with a loan, so I have no personal experience with them. But, if you have one, you need to know about it!
4. Is there a limit to the number of ‘extra payments’ I can send?
Some credit card companies limit the number of transactions that can be INITIATED from their websites. In other words, if you are going to your credit card company’s website and ‘pulling’ money from your checking account, these types of transactions may have a ‘per month’ limit. To avoid these limits – login to your online banking account and ‘send’ money to your credit card company. In other words, as in question 2, YOU will initiate the transaction on ‘your side’ and you will not be using the credit card company’s ‘payment service’.
5. How is my interest calculated?
Interest calculation is a ‘complex topic’. I’m working on a post about the subject – it should be ready for release in a few days. But, suffice to say, you need to have a basic understanding about how your creditors are calculating your interest. For most loans, the SOONER you make a payment, the LOWER your calculated interest will be. But, to be sure, contact your creditor and ask!
Now, I know what some of you are thinking. Why would my creditor be willing to answer my questions about debt reduction? Well, companies are bound by law to be honest with their customers. If you don’t feel like you are being told ‘the whole truth’, request a conversation with a manager or supervisor. The goal is to gather as much information as you can. Don’t be intimidated. Ask questions, listen, take notes, and be polite. If you don’t FULLY understand an answer, rephrase the question. Again, our goal is to get out of debt – and part of that process is understanding how your creditors handle extra payments.
If you have additional questions that you think should be asked, leave a comment and let us hear from you.
Indeed. I’ve heard of people getting in trouble for trying to prepay and the like. At least a few simple calls can set you up for paying off the rest of the loan.
Thank you! This is such an important subject.
It’s really crucial at the time you’re applying for a loan to determine whether you’re even allowed to prepay, and whether you’ll be hit with a penalty if you pay off the principal early.
I was amazed when my credit union applied a $350 check to interest, after I had written ON THE CHECK and physically taken the check in to a teller and said it was to be applied to principal only. She assured me that would happen. When I discovered they’d used about 95% of it to “prepay” interest, I was furious.
Then they tried to tell me it’s against the law for them to accept payments toward principal. I assured them it was not. They then tried to say it was against the credit union’s policy. I told them THAT probably violated the law. By now my voice was rising. When I remarked (perhaps a bit too vocally) that I was going to complain to the federal banking commission, magically the entire dilemma evaporated.
Turns out there’s a secret code to write on the check–“LOPC”–that will speed the payment on its way toward principal reduction.
Great post.
One thing I would add is be sure to ask them how they will distribute your payments – oftentimes credit card issuers make all of your repayments go to your lowest-interest debts first!
May I point out that there’s an old Wall Street canard “when in a hole, stop digging”? All to often, I see folks prepaying one debt while incurring another. I saw one youngster on a program to make double mortgage payments while sloppily handling their credit card incurring fees and extra interest. Sort of like moving the water from the shallow to the deep end of a pool. Also, I see some prepaying “good debt” (i.e., a low interest primary mortgage) with zero in emergency or retirement funds. It’s important while one is lowering the over all level of the “debt” lake, that one is preparing for all sorts of things. Don’t kid oneself in this critical effort of improving one financial health; it all about balance and making smart decisions.
Interestingly, I had a car loan at a credit union that both prepayed and paid down principal all at once. Any extra payment applied to the loan was immediately applied to the principal, but it also made my next due date later. I know it applied to the principal because the principal on the account kept showing lower and lower, but by when the loan was finally paid off (~3.25 years on a 60 month loan), it showed the next due date for the loan was over 12 months away!
I am sure however that this is not standard for most banks.
@Matthew – I have seen this as well.
@reinkefj – Step “A” – Stop using credit cards! 🙂
NCN
Good topic! It seems I’m asked almost every day about how interest calculates on a loan, so I wrote this post
http://moneyandcredit.blogspot.com/2007/05/how-to-calculate-interest-on-consumer.html . I look forward more about loan interest calculations when you have more info.
In my experience, people confuse daily interest accrual with monthly amortized interest. Maybe this is something that you can address for us? Thanks again!
Too many people never ask the second question. If they did they would know what and how much they can save. I used the method to pay off my college loans. Cut about a year off of them.
@Funny: Why do I get the feeling that credit union’s gonna lose a customer? 🙂
Great article. I’m linking to it tomorrow in my roundup, and will probably print it out and save it for my own use.
@Dana – Thanks! That would be awesome…
@Roman – A year? That’s great!
Luckily both my student and car loans both pay down the principal and forward the due date. After deciding to make extra payments I called and asked both companies what their policies are. An important second step after asking all of those questions was to send a test payment and do the math. When the payment was applied to my account I made sure that my principal amount decreased accordingly.
Though I’ll keep paying in my usual fashion my due dates are in May, June, and September.