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Refinancing: The Misperception of “Skipped Payments”
For many years, a refinance has been a great way for borrowers to lower their monthly mortgage payments, lower their interest rate, lower their loan term, change their amortization from adjustable to a fixed rate, or cash out equity from their home. While a refinance is a valuable option to meet your housing goals, there is also an increasing amount of misleading information provided to shoppers, such as being able to “skip 2 payments” which is even being marketed by some lenders as a “benefit” of the refinancing process.
In trying to compete for business, mortgage companies are also using the ability to “skip 2 payments” as a sales pitch to convince more borrowers to refinance. While a refinance loan can be structured to allow the borrower to technically “skip” 2 months of payments, the ability to do so should not be confused as a money-saving feature as some mortgage advertisements seem to suggest. The explanation below will familiarize you with the concept of “skipping” payments during the mortgage refinancing process and why it should not be considered as a money-saving feature.
Let us first understand the following two factors associated with mortgages:
- In mortgage transactions, the interest is always paid in arrears. This means that the interest owed for a particular month is paid with a payment in the following month. For example, the payment due on September 1, 2015 will include the principal and interest owed on the mortgage for the month of August 2015.
- A borrower refinancing a loan is able to roll the last two months of interest payments due from the original loan into the new loan balance. For example, if you are closing your loan on July 31, 2015 and have not made your payment for the month of July 2015 on the current loan as of closing, you will be able to “skip” the payment by rolling the interest into the payoff balance. The first payment for the new loan funding on July 31, 2015 will be on September 1, 2015, and the payment will include the interest for the month of August 2015.
Let us look at an illustration below for a loan that funds on July 31, 2015:
|MONTHLY PAYMENT DUE DATE||WHAT DOES THE PAYMENT PERIOD INCLUDE?||PAYMENT IS REQUIRED?|
|June 1, 2015||Principal and interest for May 2015 on the original loan||YES|
|July 1, 2015||Interest for June 2015 on the original loan, but this will be rolled into the new loan amount||NO|
|August 1, 2015||Interest for July 2015 on the original loan, but this will be rolled into the new loan amount||NO|
|September 1, 2015||Interest for August 2015 on the new loan||YES|
As seen from the illustration above, while the borrower gets to skip the payments during July and August 2015, the borrower is still responsible for the interest accrued on the original loan for the months of June and July, which are included as a part of the payoff. Effectively, there will not be any out-of-pocket payments for July and August because the outstanding balance will increase the payoff required by the same amount, which can result in the borrower paying thousands more in interest over the life of the loan. Borrowers should also know that even if they do decide to skip the payment during the refinance, they will be assessed a late charge if the loan is closed after the 15th of the month, because technically, a payment was not received by that time for the original loan.
In a nutshell, being able to “skip 2 payments” is actually the result of the mortgage closing/payment process. Borrowers should be aware and not perceive “skipping 2 payments” as a way to save extra money in the refinancing process. Additionally, being able to skip a payment before you are able to finalize the closing of your loan comes with its own risk, because if the loan does not fund for some reason, it can result in a mortgage payment delinquency and a negative effect on your credit rating.
Owning a home is a major responsibility. With a myriad of information available, choosing the right lender that can provide proper guidance is important. Give us a call at (787) SUN-WEST to speak to a friendly and knowledgeable mortgage professional today to learn about refinancing.