Mortgage interest is a double edge sword, on one hand it’s a tax-deductible expense, but by and large it is the heaviest cost of homeownership. What to pay attention to if you have not done a mortgage in a few years or bought a home before.
Interest Works The Opposite Of Rent
The amount of money you’re borrowing is based on a certain interest rate paid over the term of the repayment e.g. 360 months on a 30 year fixed rate. The longer the term the more interest you pay, spread out over the entire term whereas a shorter-term loan is more condensed with a higher payment, but you pay less total interest over the term. Like rent, loan interest is paid in months. Each month on a principal and interest amortizing fixed rate loan, part of your payment will go to principal with the lion’s share going to interest. It is not until year ten, the inverse occurs and more of your payment will start going to principal as the loan will be paid off in the duration of the 20 year term left of the original 30 year note.
Rent is due on the first of the month for that month’s obligation. Mortgage interest works in arrears. When you make your mortgage payment at the beginning of the month, it is for the interest of the previous month.
When Refinancing
Your principal balance on a credit report or mortgage statement is not a pay-off amount. The payoff is always higher than the current principal. The reason for this is because the lender being refinanced must estimate the amount of interest they need to collect in relationship to when they will be paid off with your new loan. The simple way to estimate a payoff when you refinance your home is to add a mortgage payment to your current principal. While this is not a hard calculation, it is a safe budgeting estimate you can use conjunction what you want your new loan amount to be.
*Recent Loan Payments Count-if your loan is closing just after the first of the month and you’ve already made your mortgage payment, expect those monies refunded to you post closing or reflective in the payoff amount. Most mortgage loan servicers are nimble enough to tie your most recent loan payment to the payoff amount. This is also a good strategy to employ reduce your numbers at loan settlement (escrow closing).
*Skipping A Payment-refinancing your home does not mean you skip out on the debt for 30 days. Let’s say you close your loan October 15, your new lender will begin charging you interest from the date they fund onward. This means you begin incurring interest from October 15 through November 1 with your first payment on the new loan not being due until December 1. While you do not make a payment in the first month after refinancing, you are still paying for it in interest the following month when the payment is due.
Buying A Home
The same interest concept applies. Your loan estimate will show the amount of prepaid interest your lender is using to estimate for the amount of time it will take for them to close escrow on your new loan. The prepaid interest amount can be adjusted based upon your closing date. Referencing our October loan closing examples, if you’re loan closing just after the first of the month, say October 5, you won’t have a mortgage payment to make on your new loan until December 1 because all of the interest for November will be reflected in the December 1 payment and the interest will be collected for October’s interest at closing in the form of prepaid interest. Interest is a driver of cash to close and is a re-occurring cost meaning it’s an ongoing expense of homeownership just like property taxes or insurance.
The more informed you are as mortgage borrower the smarter choices you can make when applying for a home financing. Remember if something does not jive within the origination of your loan, ask your loan professional. They should be able to clearly explain any and all related mortgage interest questions with your loan scenario.
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