If You Pay During the Grace Period, Beware of the Simple Interest Mortgage
This hard truth warning is for homeowners everywhere who carefully schedule their mortgage payments to arrive at the bank or mortgage processor not on the due date but on the last day of the “grace period.” By grace period, I am referring to the date by which, if your payment is not received, a late penalty is imposed. (I’m not sure why so many home owners like to push the envelope on this month after month. If you think it through, you are really only saving yourself one “grace period” worth of interest on one payment.)
A Simple Interest Mortgage and Grace Period Payments Can Cost You Extra
What You Should Do
If you are a grace period payer, you should confirm that your mortgage is not a simple interest loan. You can do this in one of three ways. The 100% accurate way is to pull out your mortgage documents and read the promissory note. A second way is to obtain a copy of your historical mortgage loan amortization schedule. If the reduction in principal portion is not steadily increasing but instead decreases at a rate that fluctuates up and down depending on when the payment was received, you’ve got a problem. The third way is to ask your mortgage lender or processor for written confirmation.
If you find out that you have a simple interest mortgage, what you should do is stop paying during the grace period. Instead, you should pay on time or even pay a little early because (unlike a conventional mortgage), an early payment will accelerate payment of the loan principal.
A Word about Mortgage Loan Terminology
In the technical worlds of accounting and finance, a simple interest loan is one in which the lender is not allowed to charge “interest on interest.” (The other type is called a “compound interest” loan.) Using that definition, the only mortgage loans in the U.S. that are not “simple interest” are loans that permit negative amortization. (Don’t get me started on those.) The more correct terminology for examining the grace period issue I am talking about is “daily accrual loan” versus “monthly accrual loan.” However, banks and mortgage lenders have traditionally used the “simple interest” label only for daily accrual loans. Therefore, if you want to confirm with your bank that you are not accruing interest daily on your mortgage loan, you might use both terms. You could say “I want to confirm that I do not have a simple interest loan, that is, that interest on my loan balance accrues monthly and not daily.” That should get you a straight answer.
Bottom line: In the world of mortgage loans, being “simple” may not be what you expect or want.