Pre-Paid Interest Explained

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What Is “Pre-Paid Interest” and Why Do I Have to Pay in Advance?

Pre-Paid Interest Explained

Take a deep breath, do not panic, and let your blood pressure return to normal. Prepaid interest is neither an advantage nor disadvantage to you. It is a neutral factor in the grand scheme of your first mortgage loan. Here is what you should know: Almost all mortgage loans are sold into the secondary market or, if not immediately sold, are “written” for future sale. All secondary market loans begin on the first of the month. If you close on any day other than the first of the month, some prepaid interest will be due the lender since they are giving you the proceeds of the loan on the day you close and will not receive a payment until some point in the future. In addition, unlike rent (which is paid in advance), mortgage loan payments are paid “in arrears” (a month behind).

Here is an example: You close your mortgage loan on the 20th of the month. You will owe ten days' interest from the 20th through the 30th of the current month. But – your first payment will NOT be due until the first day of the 2nd month. For instance, if you close on April 20th, your first mortgage payment will NOT be due until JUNE 1st, not May 1st. Therefore, if you had to pay ten days' interest up front, you still won't need a full payment for at least 40 days.

As you can see, there is neither benefit, nor harm from this. You will never pay more (or less) interest than you should. Should you be cash strapped, you should try to schedule your closing as close to the END of a month as possible. If you close your loan on the 29th, you will only be required to pay one day's interest. Should you close on the 4th of the month, you will have to pay 26 days' interest, but you'll have almost two months before your first regular payment is due. Hopefully, you see how this works out evenly for everyone. Just the timing of the first payment is affected.

   

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