Question of the Week

Question: Are we required to apply payments in a particular way? 

Answer: Generally speaking, how payments are applied is a matter of contract. Most commonly, simple interest contracts have payments applied to interest first, then principal, and the remainder to any late charges or other fees (if any), with the rest to principal. 

Some loans have a component that may need to be applied to escrow, which may be applied first or before principal if a contract specifies such an arrangement. 

In the case of late fees, it is considered an unfair practice to apply payments to late fees first, as this may cause future payments to be late even if a full payment is made (known as pyramiding). If a payment arrives that does not satisfy a periodic payment plus all late charges, the payment for that period should be considered satisfied, moving the payment clock ahead to the next payment period.

These are general rules, and as always, consult with counsel if you have any questions as to proper application outside these guidelines.