A common misconception among homeowners is whether they can skip payments when refinancing. After all, who wouldn’t want to go a couple months without a mortgage payment?
The short answer is: Yes, you can go two months without a payment, however, no payments are actually skipped.
Here is how “skipping” payments works:
Interest is paid in arrears
When you make your mortgage payment, you are actually paying the interest that accumulated during the previous month. For example, when you pay your mortgage in August, you are paying the interest that accumulated during July. This is the opposite of paying rent, which is paid in advance.
Understand your payoff demand
As part of the refinance, a payoff demand is generated from your existing servicer (the company you pay your mortgage to). Your payoff demand is the total amount needed to pay your existing loan in full.
It is common for borrowers to think their unpaid principal balance is the total amount they owe. Not true. The payoff demand is always higher than the unpaid principal balance because the payoff includes unpaid interest.
Interest accrues on your mortgage everyday. So if you close your refinance on the 15th of the month, your payoff demand will have at least 15 days of unpaid interest.
Interest is prepaid at closing
When you close your refinance, you prepay interest until the end of the month. Let’s assume you close your refinance on the 10th of the month: your closing disclosure will show a cost of 20 days of prepaid interest.
Keep in mind, prepaid interest is calculated based on your new interest rate. So while it may appear that closing at the end of the month decreases closing costs, it just means that more unpaid interest is tacked onto your payoff demand.
Going one month without a payment Since you prepay interest at closing, and interest is paid in arrears, your first payment on the new loan is not due until one month after closing. Thus, you always go one month without a mortgage payment.
For example, if you close your refinance on June 15th, your first payment is not due until August 1st. So while no interest is skipped, you effectively went the month of July without a mortgage payment.
Wait, you said TWO months without a payment
When you close your refinance, and your payment for that month is still outstanding, you do not have to make that mortgage payment.
For example, let’s assume you close your refinance on June 10th but have yet to make your June mortgage payment. Your first payment is still not due until August. Thus, you effectively went two months, June and July, without a mortgage payment.
Avoid a late payment on your credit
Your mortgage servicer will only report you late to the credit bureaus when your payment has been outstanding for more than 30 days. So if your refinance funds on June 30th, and you never made your June payment, there is no late payment reported.
If your payment is more than 30 days late, a late payment will be reported to the credit bureaus you will no longer qualify for a refinance.
Pros and cons of going two months without a payment
Structuring your refinance to go two months without a payment has many benefits: you can pay off other debt, add to your savings, or free up cash for any closing costs that have to be paid out-of-pocket.
Just know, that no interest is being skipped and the unpaid interest will be added into your payoff demand, making your new loan amount higher.
If you want to structure your refinance to go two months without a payment I have three pieces of advice: 1) never stop making mortgage payments until your refinance funds; 2) always keep the money for the payment in your account, just in case your refinance does not close in time; 3) don’t choose a broker or lender just because they promised skipping payments.