Does closing a loan on a certain day of the month save you money?
April 6th, 2007 by KenricListen, interest is charged from the day you borrow the money to the day that you pay it back. There are no free days. This is true when you buy or sell.
So let’s see what really happens…
First, we should understand that the interest you are paying on your home is for the month that just passed. When you write your check for May 1st, you are paying for April 1st to April 30th.
I had heard this discussions like this many times at work.
Mike closes on his new house on March 31st, he’s written a check at closing for his downpayment and prepaids! Now his first payment is due on May 1st for the interest during April 1-30.
Tom closes on his new house April 1st and his first payment isn’t due until June 1st. He tells Mike, “Dude, you should have closed a day later. Now you have to pay in May and I get May for free. You’re so stupid.”
How did closing one day apart enable Tom to skip his May 1st payment? It’s simple, Tom already made his payment for May 1st when he closed.
If you look at a HUD-1 closing statement there are settlement charges that the borrower pays at closing. Part of the settlement charges are line 900, Items Required by Lender to be Paid in Advance. Read that carefully, it says paid in advance. Line 901 is the interest charged between certain days.
So getting back to the example above. Mike having closed on March 31st has paid no interest in advance. Mike will pay for April’s interest on May 1st.
Tom who closed on the 1st of the month will pay interest for April 1st to April 30th in advance. Tom who probably didn’t read his HUD-2 very carefully has prepaid interest for the entire month of April’s during closing on April 1st! Tom actually made his payment 30 days earlier than Mike. Now, who’s the stupid one?
In reality unless your mortgage payment is super high and you’re getting alot of interest, it really doesn’t matter what day you close. Making prepaids at closing on your mortgage isn’t costing you enough money for it to come into play.
Posted in Finances | 6 Comments »
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I think the misconception in this issue is highly related to a lot of people getting loans that included the closing costs, so for them it does seem like “savings”. But you are right, you are paying for that, either now or later, you will pay for that. In one closing I did we had planned to close say Wednesday so the payoff amount was calculated for that day, but we actually ended up closing two days later. I got a “bill” later for like 3 dollars to cover for the interest for those extra days. Banks WILL NOT give you anything for free, not even a couple of cents.
By Andres on Apr 6, 2007
I agree that the date doesn’t matter when you’re closing on your own house.
It can matter, however, when you’re working with an investment property. In this sense, it’s all about cash flow and not total outlay.
Depending on when you close on an investment deal, it affects how much of the existing tenants rents are prorated to you and also when your first payment is due. Therefore you can essentially collect 2 months worth of rent before your first payment is due.
So, it can matter, but not really if you’re just buying your own home. Good topic to bring up though.
-limeade
By limeade on Apr 6, 2007
Limeade, I agree with you to some extent about investment properties.
The same applies in an investment property, you pay interest from the day you close. However, if you’re coming from a 1031 exchange, you can use the proceeds for prepaid interest thus reducing your out of pocket expenses.
If you’re paying closing costs out of pocket, I don’t see how this would work to your advantage because its an investment property.
By Kenric on Apr 6, 2007
Andres brought up a good point about closing costs. In cases where you get the seller to agree to pay for all closing costs or up to a certain amount. Its beneficial for you to get as much prepaid interest into the closing costs as possible.
For example, if the seller is paying up to $5,000 in closing costs and your closing costs are only $4,500. Why not move the closing so that the prepaid interest equals $500?
By Kenric on Apr 6, 2007
It works to your advantage when it’s an investment property because someone else is making your payment. If you close early in the month, you pay more prepaid interest, but the seller has to give you the rent for that month as well. Since the rent is more than all your expenses (why else would you buy it) you get an extra month of positive cash flow. Plus, if you close on, say, the third, you get the entire months rent but don’t have to pay 3 days worth of interest.
The big difference is who is paying for the property. If it’s a good investment, the tenant is paying for it. So who cares that the prepaid interest is more, the tenant should be more than covering it.
Does this make sense?
-limeade
By limeade on Apr 6, 2007
One thing I always watch when buying a property or selling a property is making sure I don’t buy right before the taxes are due or sell right after the taxes are due.
This manily works when buying a home as you can time it better.
By Quickbeam on Apr 7, 2007