Why am I charged a partial month of interest when my mortgage closes?
Mortgage interest is charged in arrears, which means your monthly payment covers your interest cost for the prior month. For example, your payment due on August 1st actually pays the interest you owe for July.
The only time you do not pay interest in arrears is when your mortgage closes. At closing the lender collects interest from the date of your mortgage closing until the end of the month in which your mortgage closes.
For example, if your mortgage closes on March 15th, you are required to pay interest for March 15th through March 31st, which is 17 days of interest expense. You are required to pay this interest cost when your mortgage funds so it is also called prepaid interest, because you are paying it in advance.
The amount of prepaid interest due at closing depends on your loan amount, mortgage rate, when your loan closes and the number of days in the month that your loan closes. The example below outlines the partial interest due at closing for a $100,000 mortgage with a 4.000% mortgage rate that closes on March 15th.
Mortgage Prepaid Interest Example
Annual interest cost: $4,000 (4.000% * $100,000)
Daily interest cost: $10.96 ($4,000 annual interest cost / 365 days per year)
Number of days from closing until end of month: 17 days (March 15th - March 31st)
Prepaid interest due at closing: $186
The example above demonstrates the mechanics for calculating the partial interest expense due when your mortgage closes. Your actual prepaid interest cost depends on your specific mortgage terms and closing date. It is important to highlight that the earlier in the month your mortgage closes, the higher your partial interest cost while the later in the month your loan closes, the lower your interest cost.
Borrowers should be sure to account for prepaid interest expense because it is an extra cost due when your mortgage closes, in addition to your down payment, other recurring and non-recurring closing costs and any reserves you are required to hold. All of these costs add up, and your partial interest expense may be significant if you have a high loan amount and mortgage rate.
The good news is that your first full mortgage payment is not due until the first day of the second month after your mortgage closes (so if your mortgage closes on March 15th, your first payment is due May 1st).
This does not mean you get to skip a mortgage payment -- there is nothing free when it comes to mortgages. Your prepaid interest payment due at closing covers the month in which your mortgage closes (March in our example) and your first full payment (due May 1st in our example) covers the first full month of your mortgage (April in our example), because you pay your mortgage in arrears.
Please note that partial interest expense only applies to a home purchase mortgage and is different than the interest you are charged when you close a refinancing. With a refinance you are charged a full month of interest at closing.
Sources
“What are prepaid interest charges?” CFPB. Consumer Financial Protection Bureau, February 24 2017. Web.
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