Courtesy of Rob Spinosa, RPM Mortgage
It doesn’t take a time traveler to appreciate the fact some folks are just inherently going to have a problem with paying today for something that won’t come due until tomorrow. Especially when that something is perhaps ill-explained and/or part of a complex real estate transaction. Even with the rollout of the CFPB’s new disclosure forms, the Loan Estimate (LE) and the Closing Disclosure (CD), consumers will likely still proffer some age-old questions about at least one component of a mortgage loan’s cost structure. So let’s hop in our DeLorean and venture to find out what is prepaid interest?
Great Scott! Why am I being charged interest on a loan I don’t have yet?
In order to understand prepaid interest, there are a few concepts we have to get straight before this baby hits 88 mph and we see some serious sh*t. Let’s ponder these for a nanosecond:
#1: Mortgage interest is paid in arrears.
“I live in the house in May and I make the payment for that time on June 1.”
#2: Rent is paid in advance.
“I pay the landlord on May 1 and that covers the time I live in the house in May.”
#3: Mortgage servicers will always collect a full month’s payment on the first of the month.
“Doesn’t matter how many days in the month, my FULL payment is always due on the first.”
These are the essentials. It is not rocket science. Now let’s synchronize our watches and light this candle.
Where We’re Going, We Need These Roads
Let’s assume you are buying a home and your close date is the 15th of July. Let’s also assume you’re presently renting. You look at your closing statement and you see 16 days of prepaid interest:
#1: The interest you are “prepaying” here covers you from July 15th through July 31. You will own the home during that time.
“Congrats! We get the keys on July 15!”
#2: You will NOT get an August 1 payment from your mortgage lender. You will also NOT have an August 1 rent payment. Some slightly disingenuous lenders would say you are “skipping” a payment. Don’t believe them. Trust me, all the payments are there…
“No August 1 mortgage payment and no August 1 rent payment! I could get used to this arrangement! But seriously, when do I make SOME form of housing payment?”
#3: Your first payment to your mortgage lender will come due September 1, and it will be for the entire month of August.
“Great Scott! I get it. I just need to PREPAY for the last days of August at close of escrow. The rest of my payments are picked up on a regular schedule, starting September 1.”
Extra (Interest) Credit
You may find that if you close in the very first days of the month, your lender will start your payments on the first of the next month. So in our example above, you would indeed get an August 1 payment. If this happens, you will be charged a full month of interest because, consistent with Rule #3 above, the lender will always collect a full month on the first of the month. However, you didn’t own the property the whole month. Whatever days at the beginning of the month were not yours will be “credited” to you at close of escrow as an interest credit. In all of our examples above, things change slightly if you are refinancing — get in touch if you have those questions or concerns.
While your density (yes, this is a movie reference) may have brought you to this post, know thatconfusion about prepaid interest is commonplace — even amongst the brightest stars in our sky. There should never be any reluctance to discuss this further with your real estate professional. Prepaid interest is not a “junk fee” that defies physics, it is just a function of a few simple laws of our real estate universe — the same one I thank you for crossing with me today.
Beam me up!
Rob Spinosa is a licensed mortgage professional in California (NMLS: 22343 and CA BRE: 01297944). He works for RPM Mortgage, a prominent, non-depository mortgage bank located in the San Francisco Bay Area. Rob’s been helping buyers and owners realize the dream of responsible home ownership since 1999 and has a “can do, will do” attitude to both business and life. Outside of the office, Rob is a competitive triathlete and has completed the prestigious Hawaii Ironman on multiple occasions. He can be reached at 877-270-5959 or rspinosa@rpm-mtg.com.