When you refinance your mortgage, you may be wondering why there is a charge for something called “prepaid interest.”
Essentially, prepaid interest is the interest that accrues from the date of closing until the end of the month.
Mortgage interest is paid in arrears
When you pay your mortgage, you’re actually paying in arrears. This is the opposite of rent.
For example, when you make your December mortgage payment, you’re actually paying for the month of November.
This is why you can skip 1 or 2 months when refinancing.
Loan Estimate will differ
When you apply for the refinance, the Loan Estimate will provide an estimate for prepaid interest. This is based on the date of the closing.
So if the estimated closing date is June 16th, then there will be 15 days of prepaid interest. Sometimes lenders just put 15 days of prepaid interest on the Loan Estimate because they don’t know the closing date and 15 days would be the middle of the month.
If your loan were to close on June 30th, then there would only be 1 day of interest.
Sometimes there can be negative interest… meaning the lender is crediting you.
For example, if your close on July 2nd, and your first payment is due on August 1st, then there would be 2 days of negative prepaid interest.
Summary
In summary, prepaid interest is the interest that accrues from the date of closing until the end of the month. This interest is paid in advance and is typically included in the closing costs of the refinance. It’s important to understand the different types of prepaid charges you may encounter when you refinance your mortgage so you can be prepared and make an informed decision.
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