Dear Dr. Don,
I have a home equity loan that is a simple interest loan. I make the same payment at the same time every month. The amount applied to principal and interest each month, however, is always different. Sometimes, all of the month's payment is applied to the interest expense.

The split between interest and principal fluctuates so much that I called the lender. The lender said it was a "simple interest" loan and that all home equity loans are like that.

I was told that to see less fluctuation, I had to pay on the same day each month. That's what I was doing, but the amounts still fluctuate greatly.

One month, my entire payment went to interest expense. I was aghast. I don't know how I can have a 30-year fixed-rate loan and have it paid off in that time if they take 98 percent of my payment and apply it to interest expense.

I have an amortized first mortgage. I know every month how much is going toward principal and interest. That's what I thought I was getting with my equity loan.

Can you shed some light on this for me please?
-- Diane Dilemma

Dear Diane,
A simple interest mortgage charges a daily interest expense to an accrual account. Every day that there isn't a mortgage payment, a day's interest expense is added to the accrual account.

When a mortgage payment is received by the lender, it applies the funds first to the accrued interest expense. Any remaining funds are used to pay down the principal balance. So, a day's difference in when the payment is received results in a day's difference in the interest expense.

Unlike a conventional mortgage, there is no grace period with a simple interest mortgage where interest does not continue to accrue. The grace period with a simple interest mortgage just spells out the time period before a late payment fee is charged.

There's an advantage to paying early with a simple interest mortgage, and a disadvantage to paying after the due date.

I wonder if you're taking advantage of the grace period, only to find that by doing so you're reducing the amount of principal that is paid down each month. Take a more proactive approach to paying this mortgage by making your payments on or before the due date.

For a more complete discussion about simple interest mortgages see read the discussion, " What are Simple Interest Mortgages?" by The Mortgage Professor, Jack Guttentag, on his Web site.

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