What Is Prepaid Interest On a Refinance?

I had a question come up today from a prospective client and I thought it was good enough to share. I imagine there are others out there who don’t understand what prepaid interest is when it comes to looking at their refinance closing costs.

What is prepaid interest on refinance?

Prepaid interest is interest that is paid on your mortgage(s) at closing. Mortgage interest is paid in arrears, which means when you make your monthly payments on the 1^st of any given month you’re actually paying off interest that was accrued over the previous month. 

When a person refinances, they have to pay off the principal balance of their mortgage PLUS the accrued per diem interest since the 1^st of the current month. Ordinarily this would be paid in your next mortgage payment, but you effectively pay it at closing since you won’t have to make that next payment. 

In addition, you have to prepay interest on the new loan from the date the loan is funded through the end of the current month. This is because the first payment on the new mortgage won’t be until the second month following the month of refinancing. In total, you end up paying 31-32 days of interest to cover that month.

Let me try to explain through an example…

If you were to refinance and your loan funded on January 15^th, then at closing you would pay per diem interest on the existing loan from January 1^st through January 15^th. BTW, you would have made your regularly schedule mortgage payment on January 1^st, which paid off the accrued interest from the month of December. 

In addition, you also will be prepaying interest on the new mortgage you are taking out from January 15^th-January 31^st. You WOULD NOT make a payment on February 1^st, because you paid the January accrued interest as a part of the refinance settlement charges. 

Your first payment on the new loan would be due March 1^st, which would cover the accrued interest for February.