Prepaid interest is collected by the lender, to pay for the interest charges for the remainder of the month
during which the loan closes escrow.Although you will pay prepaid interest at the time of the closing of a new loan, you will almost always skip one months mortgage payment as well.
During a refinance interest will also be charged by the preceding bank. Usually 30 days of interest is charged, above the actual principal balance, at the time the bank issues a payoff amount. This will need to be paid forward, and a reimbursement will be issued for the balance within 30 days.
If you close early in the month you can get an interest credit and pay no pre paid
interest for that month. However your payments will not skip a month and your first payment will be due on the first day of the following month.
Prepaid interest must be disclosed on the Good Faith Estimate along with other closing costs. The amount expressed on the Good Faith Estimate will correspond with the estimated closing date indicated. The amount of prepaid interest that you will actually pay at closing will correspond to the actual closing date.
Do not
confuse prepaid interest charged by the new lender for the new mortgage, with interest paid to and charged by the loan being paid off. Usually the lender being paid off will charge interest for 30 to 45 days forward from the day the
receive the payoff demand.
Closing later in the month will decrease the prepaid interest collected at closing. If you are seeking to minimize closing costs, this is something to consider.
Mortgage interests are paid in arrears, after they are earned by the banks. For instance, the interest portion of the June
mortgage payment pays for interest accrued from May 1 to May 31. Prepaid Interest, on the other hand, is interest paid on the day of settlement, prior to being earned by the bank, hence the term "pre-paid".
Prepaid interest is calculated by multiplying the per diem (per day) interest on the loan by all of the remaining days in the month (remaining days start on the day the loan funds). A refinance transaction generally funds 3 days after the closing date (Sundays and holidays excluded) and a purchase transaction generally funds on the closing date.
Example: purchase transaction closes on 01/25/06 (funds same day)
$25.50 is per diem interest on loan (interest per day)
x 7 days left in the month
= $178.50 prepaid interest on this mortgage transaction
