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Amortized Engine Order

Posted: Mon Oct 12, 2020 2:12 pm
by wtech_josh
In most loans you have Principal, Interest, Escrow & Fees

In the amortized engine what is the order in which a payment is applied?

If the buyer is late by a few months, and suddenly after 2 or 3 months makes a payment what accounts does that payment get applied to?

Does the order in which the payment is applied change or depend on whether the buyer is Current or is Late?

Re: Amortized Engine Order

Posted: Mon Oct 12, 2020 2:12 pm
by wtech_josh
The default is payments always pay into the Escrow account first, then pay off any fees on the loan, then pay off any accrued interest, and whatever’s left pays principal. This is the same regardless of whether a loan is current or past due.

I recently added (like a week or two ago) an option to have payments skip paying the fees unless the borrower paid more than the regular payment amount. The checkbox is on the Loan Settings dialog. When checked, payments will apply to escrow due first, and then towards principal and interest up to the scheduled P&I regular payments currently due, and if there’s any funds left, it’ll pay fees and then apply the remainder to interest and principal – usually just principal at this point.

The only thing affected by the current/late status is if the payment is allowed to apply towards the upcoming due date. An overpayment on the first timely payment on a current loan between two due dates won’t affect the amount due on the following due date unless the “Overpayment carry forward” option is turned on. An overpayment after the grace period ends or on a past due loan between two due dates will be permitted to apply towards both the due date before the payment and the due date after the payment.

Re: Amortized Engine Order

Posted: Mon Oct 12, 2020 2:45 pm
by wtech_josh
Is that default order you described possible to modify?

Another way to ask is how is that default order determined? What is the reason it goes First to escrow then fees then accrues interest then principal.

The reason I am asking is that I have a borrower who is Behind by several months
They are trying to catch up but questioning the payment history. They are saying to me that it is unfair that their payments are not going at all to principal.

I am going to try and explain it to them because they are sounding pretty upset and/or confused.

Do you know if there is any documentation that explains or shows this order for the Amortized engine?
Maybe I have asked you before, but is there something posted online or elsewhere that explains more about how home loans are paid back and what the rules are for applying a payment to the loan (something that comes from MoneyLender would help but also something that comes from another site would also help)

Re: Amortized Engine Order

Posted: Mon Oct 12, 2020 2:48 pm
by wtech_josh
Their lack of understanding does not make them correct. They signed an agreement to pay a debt, and that debt has a written and authorize accumulation of interest and fees. Don’t be afraid that the borrower is upset, it’s not your job to force them to comprehend. You can, by choice offer to help them understand how the mechanics of interest work. I’m only saying this to let you know that you don’t have to waive any interest just because the borrower is confused or angry. It actually sets a very bad precedent on the loan and might make future collections more difficult.

Escrow is money the lender has to pay out of pocket. Not collecting escrow on time is the lender giving an involuntary, interest-free loan to the borrower. If you don’t collect that first, you not only increase the debt owed to you, you make that debt non-interest accruing.

Fees are penalties for failing to follow the rules of timely repayment of the debt. Not collecting a fee when it becomes due sets the precedent of not collecting fees at all. There are certain legal requirements, such as the in the State of Utah, that late fees should not by themselves cause an increase in the amount of interest (even though underperformance on repayment can certainly cause the loan to accrue more interest than the originally amortization schedule). Hence the newly added checkbox to pay regular payments to P&I before fees. So, fees are collected immediately when due. When you overdraw a bank account and the bank charges an overdraft, you can’t say credit my deposit to the balance and I’ll pay the overdraft later. That’s just not how it works, even it if makes the borrower unhappy that they have to pay a fee instead of principal.

Interest is the rental paid for the use of the lender’s money. It is their service fee, their revenue and reason for doing business. Not collecting the interest when due is giving your money to another person to use and receiving no compensation in return. Interest is always paid before principal, except under very specific situations, usually where the borrower and lender are in business together and assets are changing hands in ways that mean the basis of the debt is restructuring.

Finally, timely payment of the scheduled amounts will result in a debt being paid in full and satisfied within a preset timeframe. That means, if they pay at least the scheduled amount, their interest will be no greater than the amount disclosed at the time to which the loan was agreed. If they miss a month, they must make a catch-up payment ASAP to resume to normal pay-down of the loan. They must bring the loan current. A mortgage that is 30 days past due for the life of the loan could end up costing the borrower double the amount that not missing a payment would cost (depending on interest rate and late fees, but the difference is enormous either way). If the borrower missed a payment, they need to pay the amount now due immediately to get the loan back on track and avoid having years of penalties and extra interest legally accruing in accordance with the terms of the loan.

So, give your borrower the Ledger Transactions for the Interest Account and the Ledger Transactions for the Amount Due account and the Payment Distribution. Explain to them how they got behind and until they pay the amount due on the Amount Due ledger, they will continue to underpay the interest and their loan will cost significantly more. Ask them if they have family or friends that can help them get their payments paid current, as the price of missing a month on a mortgage can easily be in the six figures when considered over an extended period.

And finally, if their repayment was due to something related to COVID-19, you might choose to defer that payment. It doesn’t waive the accruing interest, but it will at least stave off late fees. The borrower should still try to make up the difference by paying an extra 30ish% more for three or four months to get the accrued interest paid down. Another option is to use the Special Situations settings at the bottom of the Settings tab to defer the payment and waive the interest, if you believe that is the appropriate and justified course of action. Be sure to require documentation from the borrower to back up their hardship. Just forgiving a payment willy-nilly sets the precedent that you’ll forgive payments without much convincing.

The user’s guide does have some short descriptions of how the choice of loan engine affects the determination of interest and fees, but all loans run through roughly the same payment application mechanism, which follows the rules listed above. Only the checkbox in Loan Settings to “Pay regular payment before fees” will adjust the way that funds are applied from regular payments. You can mark payments as Principal Only to have all funds pay down principal, but these types of payments do not affect the amount due. You can mark a payment as Escrow Only to record a deposit to the escrow account, again leaving the amount due unchanged. Regular and Interest Only and Final payments will affect the amount due and are applied according to the rules above (except Interest Only will pre-pay interest rather than pay down any principal).