When You Refinance, You're Not Skipping Payments.

This is a common advertisement: "Refinance with us . . . skip your next payment!" or "Refinance now—no house payments for two months!"

This is not true, but because most consumers aren't aware of how they pay mortgage interest to their lender, it might seem like it. Since mortgage interest is paid in arrears, it's easy to understand how consumers can be misled.

Mortgage payments are made "backward," whereas rent payments are made "forward." When renters pay rent on the first of every month, they're paying for the month they've not yet lived in the property. They're paying rent ahead of time.

When homeowners make a mortgage payment on the first of the month, they're paying for the month they've already lived in the property. Mortgage interest accrues daily, based upon the mortgage's rate and term, and is then due on the first of the following month.

During a refinance, the prospective mortgage lender will contact the current lender for a "payoff." The payoff is the outstanding loan amount still due, plus the amount of interest that will accrue during the month in which the loan is paid off.

For example, if a refinance loan will fund on the 20th of the month, the new lender will send a written request for a mortgage payoff. The payoff will show the current principal balance, the rate, and the daily interest that will accrue and be due at closing.

Using a 30-year fixed rate of 6.50 percent on an original loan balance of $250,000, the per diem, or daily interest accrual on that note, is about $52 per day. The lender will multiply $52 by the number of days to the 20th of the month, when the loan is scheduled to fund.

The new loan is not for the unpaid balance, but for the unpaid balance plus accrued interest. In this example, it would be the $250,000 balance plus 20 days of accrued interest at $52 per day, or $1,040.

The $1,040 is added to the $250,000 to make a loan payoff to the old lender of $251,040. Because interest is paid in arrears, the interest for the month has yet to be paid, and is most often rolled into the new loan.

You aren't "skipping" a payment; instead, the interest yet to be paid for the month in which the loan was made was rolled into the new loan, just like any other closing cost. You borrowed next month's house payment.

So how does one "skip" two payments? By not making the current month's mortgage payment, which rolls in the previous month's accrued interest, and by rolling in the following month's mortgage payment.

Nothing is skipped; it's just added to the loan balance. Lenders that advertise "skipping" when you refinance with them are misleading you.

 
< Prev   CONTENTS   Next >