Understanding Prepaid Interest, Interest Credit, and Your First Mortgage Payment

When you close on a mortgage, there are several costs and fees to consider, one of which is prepaid interest. Understanding prepaid interest, interest credit, and knowing when your first mortgage payment is due can help you better manage your finances and avoid any surprises.

What is Prepaid Interest?

Prepaid interest is the interest that accrues on your mortgage loan from the closing date until the end of that month. Since mortgage payments are typically due on the first of the month and cover the interest for the previous month, lenders require you to prepay the interest for the remaining days of the month in which you close.

For example, if you close on your mortgage on September 15th, you will need to pay interest for the remaining 15 days of September. This prepaid interest is collected at closing and ensures that your first full mortgage payment covers a complete month of interest.

What is Interest Credit?

Interest credit is available if you close on your mortgage within the first few days of the month. Instead of paying prepaid interest, you receive a credit that reduces your closing costs. This means that your first mortgage payment will be due shortly after closing, rather than waiting until the first of the second month following your closing date.

For example, if you close on September 2nd, the lender might provide an interest credit for the first few days of September, effectively lowering your overall closing costs. Your first mortgage payment would then be due on October 1st, covering the interest for September.

Why Do Lenders Require Prepaid Interest?

Lenders require prepaid interest to ensure that they receive the interest owed for the days between your closing date and the end of the month. This practice helps align your mortgage payments with the standard payment schedule, where payments are due on the first of each month and cover the interest for the previous month.

When is Your First Mortgage Payment Due?

Your first mortgage payment is typically due on the first day of the second month following your closing date. This means that if you close on your mortgage in September, your first payment will be due on November 1st. This payment will cover the interest for the month of October. However, if you take an interest credit this will move up your first payment date to the first of the next Month.

Here’s a quick breakdown:

• Closing Date: September 15th
• Prepaid Interest Period: September 15th - September 30th
• First Mortgage Payment Due: November 1st (covering October’s interest)

However, if you close within the first few days of the month and receive an interest credit:

• Closing Date: September 2nd
• Interest Credit Period: September 2nd (you will get a credit for 2 days of interest, if daily interest is $100 a day, you will receive $200 credit)
• First Mortgage Payment Due: October 1st (covering September’s interest)
• Your Choice: You can choose to take this credit and have 1st Payment due October 1, or prepay the interest if you prefer to skip the October payment.
• Escrow account Impact: If you choose the interest credit, you will normally need to collect less money for the escrow account, as you'll make your first escrow payment in October, instead of November.

How to Prepare for Prepaid Interest, Interest Credit, and Your First Payment

1. Budget for Closing Costs: Include prepaid interest in your closing cost calculations to avoid any surprises at closing.
2. Understand Your Payment Schedule: Knowing when your first payment is due can help you plan your finances accordingly.
3. Ask Questions: If you’re unsure about any aspect of prepaid interest, interest credit, or your payment schedule, don’t hesitate to ask your lender or mortgage professional for clarification.

By understanding prepaid interest, interest credit, and knowing when your first mortgage payment is due, you can better manage your finances and ensure a smooth transition into homeownership.

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